The failure of financial econometrics: Estimation of the hedge ratio as an illustration

This paper demonstrates how the econometric modeling of the hedge ratio has no value added whatsoever to the improvement of hedging effectiveness and that using the socalled naïve model (a hedge ratio of one) produces similar results to those obtained from elaborate model specifications and 'sophisticated' estimation methods. The exercise involves the estimation of the hedge ratios for a position on the Singapore dollar when the base currency is the New Zealand dollar. The results, based on monthly data covering the period 1998:5-2009:9, show that the effectiveness of money market and cross currency hedging does not depend on model specification or the estimation method.