R help - Sep 2005 - minimal hedge variance ratio

Hi all

i have two data sets, spot and futures cash market prices. to estimate
the minimum variance hedge ratio, i first had a glance on the
correlation coefficient of relative price change (ln(St / St-1).
surprizingly the value is just 0.2 compared to actual price
correlation of 0.9. (i did regress the spot change on future change,
co-effi is 0.3, and R2 is only 0.025

a) in such scenario can someone help me in estimating the ratio which
are time varying.
b) is there a way to define the function as the correlation will work
at given level of basis (futures - spot).

thank u for the help and co-operation

rgds

snvk

Krishna a ??crit :
> i have two data sets, spot and futures cash market prices. to estimate
> the minimum variance hedge ratio, i first had a glance on the
> correlation coefficient of relative price change (ln(St / St-1).
> surprizingly the value is just 0.2 compared to actual price
> correlation of 0.9.
The correlation coefficient measures the strengh of *linear*
relation between 2 variables X and Y.

Thus when you replace X by X'=aX+b or Y by Y'=cY+d
(for instance use f = function(U) {return((U - mean(U))/sd(U));})
then you always have cor(X,Y)=cor(X',Y')=cor(X,Y')=cor(X',Y).

But when you use X'=f(X), Y'=g(Y) with f,g non linear functions
there is no reason to have cor(X',Y')=cor(X,Y).
... and f(X) = logreturn(X) is not really a linear transformation.

hih