Optimal hedge ratios and hedging effectiveness : an analysis of the Turkish futures market

The main purpose of this comprehensive study is to determine the optimal hedge ratios and hedging effectiveness of different futures contracts traded on the Borsa Istanbul (BIST), namely the BIST 30 equity index, US dollar–Turkish lira currency futures (USD-TRY), euro–Turkish lira (EUR-TRY) currency futures, and gold futures. The efficiency of hedge ratios estimated through constant and time-varying econometric models, such as ordinary least squares (OLS) and diagonal VECH—a multivariate generalized autoregressive conditional heteroskedasticity (GARCH) model—are compared with a minimum variance hedge ratio framework. The periods before and after the merger of the Turkish Derivatives Exchange are analyzed with the models to capture changes in the hedging effectiveness of the contracts. We find that the diagonal VECH and constant models produce almost identical positive results for both periods, suggesting similar high hedging effectiveness for BIST 30 equity futures contracts. We conclude that BIST 30 equity futures contracts provide an efficient hedging mechanism for investors aiming to protect their spot equity portfolios. However, after Turkey's foreign exchange regulation amendment in 2017, the percentage of variance reduction improves greatly for the dynamic GARCH model, compared to the static OLS model, for USD-TRY and EUR-TRY futures contracts. Furthermore, the hedging effectiveness of currency futures contracts is negatively affected during the COVID-19 pandemic period beginning in 2020. Unlike other contracts, the hedging effectiveness of gold contracts is low in all periods.