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Currency hedging strategies using dynamic multivariate GARCH

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  • Chang, Chia-Lin
  • González-Serrano, Lydia
  • Jimenez-Martin, Juan-Angel

Abstract

This paper examines the effectiveness of using futures contracts as hedging instruments of: (1) alternative models of volatility for estimating conditional variances and covariances; (2) alternative currencies; and (3) alternative maturities of futures contracts. For this purpose, daily data of futures and spot exchange rates of three major international currencies, Euro, British pound and Japanese yen, against the American dollar, are used to analyze hedge ratios and hedging effectiveness resulting from using two different maturity currency contracts, near-month and next-to-near-month contract. We estimate four multivariate volatility models (namely CCC, VARMA-AGARCH, DCC and BEKK), and calculate optimal portfolio weights and optimal hedge ratios to identify appropriate currency hedging strategies. The hedging effectiveness index suggests that the best results in terms of reducing the variance of the portfolio are for the USD/GBP exchange rate. The empirical results show that futures hedging strategies are slightly more effective when the near-month future contract is used for the USD/GBP and USD/JPY currencies. Moreover, the CCC and AGARCH models provide similar hedging effectiveness, which suggests that dynamic asymmetry may not be crucial empirically, although some differences appear when the DCC and BEKK models are used.

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Article provided by Elsevier in its journal Mathematics and Computers in Simulation (MATCOM).

Volume (Year): 94 (2013)
Issue (Month): C ()
Pages: 164-182

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Handle: RePEc:eee:matcom:v:94:y:2013:i:c:p:164-182

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Web page: http://www.journals.elsevier.com/mathematics-and-computers-in-simulation/

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Keywords: Multivariate GARCH; Exchange Rates; Hedging;

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Cited by:
  1. Chia-Lin Chang & David E. Allen & Michael McAleer & Teodosio Perez Amaral, 2013. "Risk Modelling and Management: An Overview," KIER Working Papers 872, Kyoto University, Institute of Economic Research.
  2. Andre Assis de Salles, 2013. "An Investigation of Some Hedging Strategies for Crude Oil Market," International Journal of Energy Economics and Policy, Econjournals, Econjournals, vol. 3(1), pages 51-59.
  3. Асатуров К.Г. & Теплова Т.В., 2014. "Построение Коэффициентов Хеджирования Для Высоколиквидных Акций Российского Рынка На Основе Моделей Класса Garch," Журнал Экономика и математические методы (ЭММ), Центральный Экономико-Математический Институт (ЦЭМИ), vol. 50(1), pages 37-54, январь.

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