hedging effectiveness with physical delivery and cash settlement at indian commodity futures market:...

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Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market: An Empirical Comparison Analysis Prasanna Kumar Barik Associate Fellow, C.M.D.R., Lakamanahalli, Dharwad, 580 004, India. & M V Supriya Assistant Professor Department of Management Studies Anna University, Chennai, 600 025, India.

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Page 1: Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market: An Empirical Comparison Analysis Prasanna Kumar Barik

Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market:

An Empirical Comparison Analysis

Prasanna Kumar BarikAssociate Fellow, C.M.D.R.,

Lakamanahalli, Dharwad, 580 004, India.

&

M V SupriyaAssistant Professor

Department of Management StudiesAnna University, Chennai, 600 025, India.

Page 2: Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market: An Empirical Comparison Analysis Prasanna Kumar Barik

October 10, 2007 Prasanna K. Barik, Associate Fellow, C.M.D.R., Dharwad-04.

2

Objective (s) for the Future Study

-To define and analyze the ‘hedging effectiveness’ at both the physical delivery and cash settlement at commodity futures market

- To study the relationship between the market participants’ trading strategy and the above event analysis.

-To study the impact of the market participants’ behaviour on market makings in relation to the ‘hedging effectiveness’.

Why do they like so?

Page 3: Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market: An Empirical Comparison Analysis Prasanna Kumar Barik

October 10, 2007 Prasanna K. Barik, Associate Fellow, C.M.D.R., Dharwad-04.

3

This is because,

In usual observations, the commodity futures market may have the following issues,

-Price Risk

-Basis Risk

-Market Efficiency

-Diversification of resources and thereby its impact on Economic Growth

-Trading option i.e. dependency on physical delivery or cash settlement

Page 4: Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market: An Empirical Comparison Analysis Prasanna Kumar Barik

October 10, 2007 Prasanna K. Barik, Associate Fellow, C.M.D.R., Dharwad-04.

4

In this context, the prior studies are:

Barik and Supriya (2005, 2006, 2007a and 2007b): Defined and analyzed the Market activities like hedging ratios, speculation ratios and arbitrage ratios. All are having adverse effect on profit maximization causing insolvency situation at the Nifty futures.

Gurrib, Ikhlaas (2007): Found that there is insignificant relationship between the large hedgers and speculators’ and major macro-economic events in US commodity futures market.

Kabra (2007): Questioned on the financialization of commodity market and its effect on real economy.

Bhattacharya (2007): Outlined infrastructural and regulatory matters and importantly focused on the trading option issue.

Page 5: Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market: An Empirical Comparison Analysis Prasanna Kumar Barik

October 10, 2007 Prasanna K. Barik, Associate Fellow, C.M.D.R., Dharwad-04.

5

Therefore, the “Hedging Effectiveness” hypothesis and its empirical test arises.

Understanding IGARCH (1, 1) model of Barik and Supriya (2005, 2007a and

2007b) and Considering Multivariate GARCH (1, 1) model, this study will follow

Park and Switzer (1995) Bivariate GARCH (1, 1) model. This is follows as:

At Cash Settlement:

Ftttt

Stttt

FSF

FSS

1111101

1111101

Where,

ttFtSt HN ,0~|, 1

tF

tS

tF

tS

tFFtSF

tSFtSSt h

h

h

h

hh

hhH

,

,

,

,

,,

,,

0

0

1

1

0

0

21,

21,

2

21,

21,

2

tFFtFFFFt

tSStSSSSt

hbach

hbach

Then

tFF

tSFth

hb

,

,*1 ˆ

ˆˆ

Page 6: Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market: An Empirical Comparison Analysis Prasanna Kumar Barik

October 10, 2007 Prasanna K. Barik, Associate Fellow, C.M.D.R., Dharwad-04.

6

At Physical Delivery Settlement

Qtttt

Ttttt

QTQ

QTT

1211202

1211202

ttQtTt HN ,0~|, 1

Where,

tQ

tT

tQ

tT

tQQtTQ

tTQtTTt h

h

h

h

hh

hhH

,

,

,

,

,,

,,

0

0

1

1

0

0

21,

21,

2

21,

21,

2

tQQtQQQQt

tTTtTTTTt

hbach

hbach

Then,

tQQ

tTQth

hb

,

,*2 ˆ

ˆˆ

Page 7: Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market: An Empirical Comparison Analysis Prasanna Kumar Barik

October 10, 2007 Prasanna K. Barik, Associate Fellow, C.M.D.R., Dharwad-04.

7

For data, we will depend on NCDEX and if there is need, we will depend on primary study at NCDEX. For the estimation, the Regression Analysis on Time Series (RATS) econometric package will be used.

References

Barik, Prasanna K. and M. V. Supriya (2005), “Signaling In Indian Futures Market”, The ICFAI Journal of Applied Finance, April 11(4), pp. 13-30.

Barik, Prasanna K. and M. V. Supriya (2006), “Signaling in Indian Derivatives Market: A Study on Futures Market”, Management Matters, Volume 1, Issue 6 (March-August), pp.119-122.

Barik, Prasanna K. and M. V. Supriya (2007), “S & P CNX Nifty Futures at NSE India: An Empirical Analysis, Asia-Pacific Business Review, Volume 3, Number 1 (January-June), pp. 67-90. [a]

Barik, Prasanna K. and M. V. Supriya (2007), “Signaling in S & P CNX Futures Market at NSE, India”, Forthcoming in the journal of ‘Decision’, Indian Institute of Management, Calcutta, [b]

Page 8: Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market: An Empirical Comparison Analysis Prasanna Kumar Barik

October 10, 2007 Prasanna K. Barik, Associate Fellow, C.M.D.R., Dharwad-04.

8

Bhattacharya, Himadri (2007), “Commodity Derivatives Market in India”, Economic and Political Weekly, Vol.XLII, No. 13 (March 31), pp.1151-1162.

Gurrib, Ikhlaas (2007), “Do large Hedgers and Speculators React to Events? An Analysis of Stability and Events”, The ICFAI Journal of Financial Economics, Vol. V, No.2, pp.31-41.

Kabra, Kamal Nayan (2007), “Commodity Futures in India”, Economic and Political Weekly”, Vol.XLII, No. 13 (March 31), pp.1163-1170.

Park, Tae H. and Lorne N. Switzer (1995), “Bivariate GARCH Estimation of the Optimal Hedge Ratios for Stock Index Futures: A Note”, The Journal of Futures Markets, Vol.15, No.1, pp.61-67.

http://www.thehindubusinessline.com

http://www.ncdex.com

Page 9: Hedging Effectiveness with Physical Delivery and Cash Settlement at Indian Commodity Futures Market: An Empirical Comparison Analysis Prasanna Kumar Barik

October 10, 2007 Prasanna K. Barik, Associate Fellow, C.M.D.R., Dharwad-04.

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Now, I require suggestions and comments on this research proposal.

Thank You