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Futures market efficiency and effectiveness of hedge in Indian currency market

Varuna Kharbanda (Delhi School of Management, Delhi Technological University, Delhi, India)
Archana Singh (Delhi School of Management, Delhi Technological University, Delhi, India)

International Journal of Emerging Markets

ISSN: 1746-8809

Article publication date: 29 November 2018

668

Abstract

Purpose

Corporate treasurers manage the currency risk of their organization by hedging through futures contracts. The purpose of this paper is to evaluate the effectiveness of hedging by US currency futures contracts by taking into account the efficiency of the currency market.

Design/methodology/approach

The static models for calculating hedge ratio are as popular as dynamic models. But the main disadvantage with the static models is that they do not consider important properties of time series like autocorrelation and heteroskedasticity of the residuals and also ignore the cointegration of the market variables which indicate short-run market disequilibrium. The present study, therefore, measures the hedging effectiveness in the US currency futures market using two dynamic models – constant conditional correlation multivariate generalized ARCH (CCC-MGARCH) and dynamic conditional correlation multivariate GARCH (DCC-MGARCH).

Findings

The study finds that both the dynamic models used in the study provide similar results. The relative comparison of CCC-MGARCH and DCC-MGARCH models shows that CCC-MGARCH provides better hedging effectiveness result, and thus, should be preferred over the other model.

Practical implications

The findings of the study are important for the company treasurers since the new updated Indian accounting standards (Ind-AS), applicable from the financial year 2016–2017, make it mandatory for the companies to evaluate the effectiveness of hedges. These standards do not specify a quantitative method of evaluation but provide the flexibility to the companies in choosing an appropriate method which justifies their risk management objective. These results are also useful for the policy makers as they can specify and list the appropriate methods for evaluating the hedge effectiveness in the currency market.

Originality/value

Majorly, the studies on Indian financial market limit themselves to either examining the efficiency of that market or to evaluate the effectiveness of the hedges undertaken. Moreover, most of such works focus on the stock market or the commodity market in India. This is one of the first studies which bring together the concepts of efficiency of the market and effectiveness of the hedges in the Indian currency futures market.

Keywords

Citation

Kharbanda, V. and Singh, A. (2018), "Futures market efficiency and effectiveness of hedge in Indian currency market", International Journal of Emerging Markets, Vol. 13 No. 6, pp. 2001-2027. https://doi.org/10.1108/IJoEM-08-2017-0320

Publisher

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Emerald Publishing Limited

Copyright © 2018, Emerald Publishing Limited

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