The spider in the hedge

Alexander, Carol and Barbosa, Andreza (2005) The spider in the hedge. Review of Futures Markets, 14 (1). pp. 93-116. ISSN 0898-011X

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Abstract

This paper provides an empirical study of the effectiveness of hedging the spider (or SPDR). a passive exchange traded fund (ETF) that replicates the S&P500 index. The spider is by far the largest ETF in the world: Trading on the spider has grown so much during the past few years that it is now amongst the few most traded securities in the AMEX. The large net daily creation and redemption orders of recent years pose a problem to the market makers in the spider, as the orders may be too large to execute in the cash market. They face a decision about whether to hedge spider positions on their own book, and if so, how should they hedge? We have employed several sophisticated minimum variance estimates for the futures hedge ratio, including OLS regression, an ECM to account for maturity effects and the cointegration of the spot and the future prices, and to the ECM residuals we apply EWMA and number of bivariate GARCH models to account for time-variation in the hedge ratio. We have applied these models to daily data for a one-day rebalancing frequency and to weekly data for a five-day rebalancing frequency, using data since the spider's inception until the end of 2004. Marginal differences in the "optimal" hedge ratios are apparent, but they are simply too small to have any significant effect on the hedged portfolio volatility. In out-of-sample testing, we find that the naive hedge, where an equal and opposite position is taken in futures, performs as well as the more technically sophisticated models at both the daily and the weekly re-balancing frequency. Finally, we have considered the differences between hedging the spot index and hedging the spider. The efficiency of hedging the spider is superior to that of the index and the spider hedged portfolios have significantly lower volatility than the spot index hedged portfolios

Item Type: Article
Schools and Departments: School of Business, Management and Economics > Business and Management
Subjects: H Social Sciences > HG Finance
Depositing User: Carol Alexander
Date Deposited: 17 Sep 2012 11:46
Last Modified: 17 Sep 2012 11:46
URI: http://sro.sussex.ac.uk/id/eprint/40599
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