Usefulness of Treasury Bill Futures as Hedging Instruments

In a recent article, Ederington (1979) examined the hedging performance of financial futures markets using a portfolio model derived from the hedging theories of Stein (1961) and Johnson (1960). His article concluded that GNMA futures were more effective than T-Bill futures in reducing price change risk. Moreover, in the short term, the performance of T-Bill futures in reducing risk was extremely poor. The purpose of this article is to determine whether these results are due to a misspecification of the model and to test whether the hedging effectiveness of the T-Bill futures market has changed after three years of trading. A portfolio model of hedging effectiveness is formulated to account for the constant yield price accumulation over time on Treasury bills as distinguished from price changes due to instantaneous changes in yield. We test the T-Bill futures market using the portfolio model and conclude that the market provides very good opportunities for hedging, provided that the spot position is comprised of Treasury bills deliverable against the futures contract.