NONCONSTANT OPTIMAL HEDGE RATIO ESTIMATION AND NESTED HYPOTHESES TESTS zy KEVIN zyxwv P. MCNEW PAUL L. FACKLER INTRODUCTION zyxwvu There exists a large body of empirical work on the estimation of optimal hedge ratios in futures markets. The hedge ratio measures the risk minimizing proportion of futures relative to a firm’s physical position. It is equal to the ratio of the covariance of the cash and futures prices to the variance of the futures price, conditioned upon information available at the time of the hedging decision. A hedge ratio is based, in principle, on a decision maker’s subjective beliefs about the moments of the cash and futures joint distribution. In practice, however, hedge ratios are usually estimated using historical price data. Early studies [Peck (1 975); Heifner (1 972)] estimate the hedge ratio by regressing the cash price on the futures price where the coefficient estimate on the futures price gives the empirical hedge ratio. Myers and Thompson (1989) show that this method results in an unconditional hedge ratio estimate in that the covariance and variances are implicitly calculated relative to the sample means of cash and futures prices w zyxwvutsrqponm Kevin P. McNew is a Graduate Research Assistant in the Department of Agricultural Paul L. Fackler is an Associate Professor, Department of Agricultural and Resource and Resource Economics at North Carolina State University. Economics, North Carolina State University. zyxwv The Journal of Futures Markets, Vol. 14, No. 5, 619-635 (1994) Q 1994 by John Wiley & Sons, Inc. CCC 0270-7314/94/050619-17