Hedging with Gold Futures: Evidence from China and India

Abstract: Recently the National Commodity & Derivatives Exchange (NCDEX) and the Shanghai Futures Exchange (SHFE) introduced gold futures trading in India and China respectively. In developing markets like China and India it is important to manage risk. For the sake of choosing the optimal hedge strategy it is sufficient to understand and calculate the optimal hedge ratio. Therefore we divide our analyze on two parts. Firstly, we calculate optimal hedge ratios for hedging spot contracts with futures contracts. Secondly, we evaluate the hedging efficiency of these optimal hedge ratios. We use OLS, VAR and VECM models to estimate constant hedge ratios and VAR-MGARCH to estimate dynamic hedge ratios. It is found that for both China and India VAR-MGARCH model estimates of the time varying hedge ratio give higher volatility reduction compare to the hedge ratios based on models with constant hedge ratio. From the empirical results, we found that Indian gold futures market is effective and Chinese gold futures market is less effective. Overall, gold futures contracts in China and India prove to be a smart and well-needed hedging tool for clever investor.