A note on a risk-return measure of hedging effectiveness

Abstract

In a recent paper, Kuo and Chen (1995) propose a simplification of the Howard and D'Antonio (1984, 1987) model of hedging effectiveness. This note extends Kuo-Chen's suggested simplification to derive the optimal hedge ratio and second order conditions (SOCs) of the Howard-D'Antonio model. These SOCs were previously reported incorrectly by both Howard and D'Antonio (1984, 1987) and Chang and Shanker (1987). The corrected SOC is less restrictive than supposed previously and shows that there is no need to make a priori assumptions about risk-return relatives between spot and futures assets to ensure that SOCs conditions are satisfied. © 1998 John Wiley & Sons, Inc. Jrl Fut Mark 18:867–870, 1998