A comparison of measures of hedging effectiveness: A case study using the Australian all ordinaries share price index futures contract

Hedging is claimed to be of fundamental importance in managing the risk of an investment portfolio. Several techniques to assess the effectiveness of a hedge have been suggested in the literature. While these techniques hold theoretical appeal, there is little empirical evidence as to their usefulness. This paper provides an empirical comparison of three measures of hedge effectiveness in the context of hedging market risk using the Australian All Ordinaries Share Price Index Futures contract. The three measures are portfolio S.D. ranking, the Howard and D'Antonio [Howard, C.T., D'Antonio, L.J., 1987. A risk return measure of hedging effectiveness: a reply. J. Finan. Quant. Anal. 22(3), 377-381.] measure and the Lindahl [Lindahl, M., 1991. Risk-return hedging effectiveness measures for stock index futures. J. Futures Markets 11(4), 399-409.] measure. The results indicate that the selection of the particular measure of hedge effectiveness has an impact on the assessment of hedged portfolios. Further, the paper highlights problems that arise in the application of the Lindahl [Lindahl, M., 1991. Risk-return hedging effectiveness measures for stock index futures, J. Futures Markets 11(4), 399-409.] and Howard and D'Antonio [Howard, C.T., D'Antonio, L.J., 1987. A risk return measure of hedging effectiveness: a reply, J. Finan. Quant. Anal. 22(3), 377-381.] measures