A simple test of optimal hedging policy

This paper investigates the equivalence between the optimal hedge ratio derived in a risk-return simplification and the optimal hedge ratio using mean–variance analysis. In accordance with this relationship, we develop a simple regression-based test for evaluating the hedging effectiveness of the risk-return hedging. As a result, a tt-test and an FF-test are designed to examine the hedge ratio and hedging effectiveness, respectively. An example of hedging is also provided to illustrate this process.

► We model Howard–D’Antonio risk-return hedging by a regression-based approach. ► We develop att-statistic for testing the optimal hedge ratio. ► We derive an FF-statistic that can be used to evaluate the hedging effectiveness.