The volatile financial market today has taken financial risk as centre point in every sphere of economic activity. Therefore, hedging of risk has become a very important concern worldwide. However, hedging is still an underutilized tool. International practices for hedging against commodity price risk involve both static and dynamic hedging techniques. In a static hedge, the physical commodity price is locked in by hedging in Futures market. This is irrespective of whether the commodity price increases or decreases, the underlying objective being protection against market risk. In a dynamic hedge, judgmental positions are taken in Futures markets, based on specific presumptions on possible price movements in the physical market. This may depend on fundamental factors of demand and supply that impact commodity prices. Dynamic hedge involves greater risk as compared with a static hedge. Hedging using Futures Contracts involves identification and quantification of the hedge ratio (the ratio of the number of Futures contracts, each on one unit of the underlying asset to be hedged, as compared with one unit of the cash asset that needs to be hedged). The extent of volatility in Futures contract prices as compared with the volatility in cash market prices needs to be ascertained along with the correlation between the cash price and Futures price. The calculation of the hedge ratio is all the more important because of the threat of being under-hedged or over-hedged. A crucial input in the hedging of risk is the optimal hedge ratio. Numerous studies point out that the expected relationship between economic or
financial variables may be better captured by a time varying parameter model rather than a fixed coefficient model. So the optimal hedge ratio can be a time varying rather than constant. Thus, the role of hedging while using multiple risky assets, using Futures market for minimizing the risk of Spot market fluctuation has attracted considerable attention. The focus of current empirical financial research is on effective use of Futures contract in making hedging decisions and there is considerable amount of research being carried out to find optimal hedge ratio and improve the hedging effectiveness