The hedging effectiveness of stock index futures: evidence for the FTSE-100 and FTSE-mid250 indexes traded in the UK

Abstract

This study provides the first investigation of the hedging effectiveness of the FTSEMid250 stock index futures contract. In contrast to previous studies, the portfolios to be hedged are actual diversified portfolios in the form of investment trust companies (ITCs). Furthermore, in addition to using the well established hedging strategies, consideration is also given to hedge ratios estimated on the basis of the Least Trimmed Squares approach. Despite relatively thin trading, the FTSE-Mid250 contract is shown to be an important additional hedging instrument. Surprisingly, the new contract is more effective for hedging ITCs than is the established FTSE-100 contract. The study also demonstrates that previous studies overstate the hedging effectiveness of UK stock index futures, in that they assume the portfolio to be hedged is one which underlies a broad market index.