International Journal of Economics and Finance; Vol. 8, No. 7; 2016 ISSN 1916-971X E-ISSN 1916-9728 Published by Canadian Center of Science and Education 1 Measuring the Hedge Ratio: A GCC Perspective Ahmad Bash 1 , Abdullah M. Al-Awadhi 1 & Fouad Jamaani 1 1 School of Economics, Finance and Marketing, RMIT University, Australia Correspondence: Ahmad Bash, School of Economics, Finance and Marketing, RMIT University, Melbourne VIC 3000, Australia. Tel: 61-447-718-868. E-mail: ahmad.bash@rmit.edu.au Received: March 29, 2016 Accepted: April 16, 2016 Online Published: June 25, 2016 doi:10.5539/ijef.v8n7p1 URL: http://dx.doi.org/10.5539/ijef.v8n7p1 Abstract In this paper, we examine the effectiveness of minimising the variance of the hedge ratio using different econometric models for the GCC currencies under money-market hedging and cross-currency hedging. Specifically, we determine whether different model specifications and estimation methods yield different hedge-effectiveness results. In other words, does the sophistication of the model improve the effectiveness of the hedge? Our results show that these econometric models fail either to add value or to improve the effectiveness of the hedge. Keywords: Gulf Co-operation Council (GCC), risk-minimizing hedge ratio, money-market hedging, cross-currency hedging 1. Introduction After the collapse of the Bretton Woods system and the introduction of flexible exchange rates in the early 1970s—coupled with the tendency of firms to engage in international business—the need has arisen to pay attention to fluctuations in exchange rates. Exchange-rate volatility affects not only firms that operate in international markets, but also domestic firms that compete with other firms that import goods from abroad, as well as purely domestic firms such as utility providers. In other words, even domestic firms that operate in the local market are affected by currency fluctuations (Adler & Dumas, 1984; Aggarwal & Harper, 2010). This paper is concerned with the management of foreign-exchange risk from the perspective of a domestic firm operating in a member country of the Gulf Co-operation Council (GCC). This is a bloc of countries in the Middle East that includes Kuwait, Kingdom of Saudi Arabia (KSA), United Arab Emirates (UAE), Bahrain, Qatar, and The Sultanate of Oman. Apart from Kuwait, which pegs its currency to a basket of currencies, all of these countries adopt a fixed exchange-rate regime in which they peg their currencies to the US dollar. While a policy of pegging to the dollar keeps the exchange rate against the dollar stable, the exchange rates against other currencies remain volatile. Since these countries trade more with the European Union, Japan, and China than with the United States, exposure to foreign-exchange risk is a major issue of concern for businesses using one of the GCC currencies as a base currency. Given that these countries also lack sophisticated financial markets, hedging exposure to foreign-exchange risk becomes a rather challenging task. Researchers have been widely estimating the hedge ratio using the ordinary least squares (OLS) estimation method. However, in the financial-econometrics literature, there are many other estimation methods that can be used to estimate the hedge ratio empirically apart from OLS. In this paper, we examine the effectiveness of minimising the variance of the hedge ratio using different econometric models for the GCC currencies under money-market hedging and cross-currency hedging. The purpose of this paper is to determine whether different model specifications and estimation methods yield different hedge-effectiveness results. In other words, does the sophistication of the model improve the effectiveness of the hedge? Our results show that these econometric models fail either to add value or to improve the effectiveness of the hedge. The results from this paper may be beneficial for the managers of firms engaged in international trade, as well as researchers interested in foreign-exchange risk management. In addition, the results will add value to those agents who employ hedging techniques using the currencies of developing countries that lack sophisticated financial markets. This paper starts with a literature review in Section 2, followed by discussion of the methodology in Section 3, data and empirical results are in Section 4 and the conclusion is in Section 5.