The influence of the COVID-19 pandemic on the hedging functionality of Chinese financial markets Research in International Business and Finance

In this paper, we investigate both constant and time-varying hedge ratios in terms of the effec- tiveness of CSI300 index futures during the COVID-19 crisis. Using naïve, OLS and EC/ROLS strategies to estimate constant hedge ratios, results indicate that the CSI300 spot index presents decreased effectiveness using the naïve hedging strategy; however, increased effectiveness of OLS and EC hedge ratios are identified. Differential behaviour is identified when considering five newly introduced COVID-19 concept-based stock indices. Time-varying hedge ratios indicate the weakened effectiveness, ranging between 20% and 40% variance reduction. Evidence suggests that the capability of the CSI300 index futures to hedge against the risks of the COVID-19 is impaired, regardless of whether constant or time-varying hedge ratios are used. Such results provide important implications to both local and foreign investors in the Chinese stock market. performance against such COVID-19 Chinese concept-based stock indices, providing important evidence as to how efficient the Chinese stock index futures are when mitigating the effects of market turmoil developed by the COVID-19 pandemic. To complete such analysis, we develop constant hedging strategies including naïve, Ordinary Least Squares (OLS) and Error Correction (EC)/ Revised OLS (ROLS) hedging mechanisms. The selected time-varying hedging strategies are based on the bivariate generalised autoregressive conditional heteroscedasticity (GARCH) with the specifications of constant conditional correlation (CCC), dynamic conditional correlation (DCC) and asymmetric DCC (ADCC) methodologies. Specifically, with the utilisation of these strategies, we construct direct hedging portfolios against the CSI300 spot index and cross-hedging portfolios against five COVID-19 concept-based stock indices including coronavirus, influenza, facemask, coronavirus detection and disinfectant, by using the CSI300 stock index futures. Hedging effectiveness, in light of variance reduction, is assessed for constant and time-varying strategies and compared against each other. We examine whether hedging effectiveness differs between the pre-and post-COVID-19 periods while examining the optimal strategy in both pre-crisis and crisis periods, the results of which are indicative of the effect of COVID-19 on the optimal level of cross-hedging. The effect of transaction costs on hedging effectiveness is also investigated. Results indicate that the COVID-19 period enhances estimated hedging effectiveness for two of the three constant hedging strategies (OLS and EC). Concerning constant cross-hedging within the COVID-19 concept-based stock indices, variance reduction falls from approximately 49% to 61% in the pre-COVID-19 period to a range between 11% and 45% as the COVID-19 pandemic begins. In contrast, time-varying direct hedging based on the CSI300 spot index experiences a reduction in hedging effectiveness between the pre-to post-COVID-19 periods. Time-varying cross-hedging over the COVID-19-related a hedging strategy for CSI300 index futures where they suggest that the regime-switching BEKK-model provides better performance compared to the BEKK-GARCH and OLS based hedging strategies. Qu et al. (2019) develop dynamic hedge ratios using high-frequency data based on the realised minimum variance (RMV) approach and assess its hedging performance against a set of alternative constant and time-varying hedging ratios. They show that the RMV hedge ratios outperform the other approaches, where the results are found to be robust across several different market structures and volatility regimes. in the prices of the CSI300 index and index futures are observed after the COVID-19 outbreak. These observations suggest that even though the COVID-19 outbreak broadly negatively impacts stock markets in China, the firms that are heavily involved in pandemic-related activities obtained larger returns when compared to the pre-COVID-19 period. It is therefore of interest to explore whether the CSI300 stock index futures can provide an efficient hedging function compared to the COVID-19 related index portfolios. Unit root tests suggest that all the price series are integrated of order 1, I(1), while all the return series are integrated at order 0, I(0), during both the pre- and post-COVID-19 periods. We use the Johansen cointegration test to consider the existence of cointegration between the CSI300 index futures and the other indices. Note that the test applies to the pre-defined in-sample estimation window of both the pre-and post-COVID-19 sample periods. We find that in both periods, the CSI300 spot and index futures prices are cointegrated. In the pre-COVID-19 period, the influenza index prices are cointegrated with the CSI300 index futures prices. For the cointegrated series, we employ a vector error correction model (VECM) to model the conditional means of the bivariate SNP distribution. The cointegration test rejects cointegration between the CSI300 index futures and the other index series in the rest of the sample periods. Henceforth a vector autoregressive (VAR) model is used to model the conditional means 8 . the noted Chinese stock