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Dynamic futures hedging in currency markets

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Author Info

  • Atreya Chakraborty
  • John Barkoulas

Abstract

The hedging effectiveness of dynamic strategies is compared with static (traditional) ones using futures contracts for the five leading currencies. The traditional hedging model assumes time invariance in the joint distribution of spot and futures price changes thus leading to a constant optimal hedge ratio (OHR). However, if this time-invariance assumption is violated, time-varying OHRs are appropriate for hedging purposes. A bivariate GARCH model is employed to estimate the joint distribution of spot and futures currency returns and the sequence of dynamic (time-varying) OHRs is constructed based upon the estimated parameters of the conditional covariance matrix. The empirical evidence strongly supports time-varying OHRs but the dynamic model provides superior out-of-sample hedging performance, compared to the static model, only for the Canadian dollar.

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File URL: http://www.tandfonline.com/doi/abs/10.1080/135184799336975
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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal The European Journal of Finance.

Volume (Year): 5 (1999)
Issue (Month): 4 ()
Pages: 299-314

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Handle: RePEc:taf:eurjfi:v:5:y:1999:i:4:p:299-314

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Related research

Keywords: Dynamic Hedging; Optimal Hedge Ratio; Bivariate Garch Model; Currency Futures;

References

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  1. Cecchetti, Stephen G & Cumby, Robert E & Figlewski, Stephen, 1988. "Estimation of the Optimal Futures Hedge," The Review of Economics and Statistics, MIT Press, vol. 70(4), pages 623-30, November.
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  16. Figlewski, Stephen, 1984. " Hedging Performance and Basis Risk in Stock Index Futures," Journal of Finance, American Finance Association, vol. 39(3), pages 657-69, July.
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Citations

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Cited by:
  1. Su, Yongyang & Lau, Chi Keung Marco & Tan, Na, 2013. "Hedging China’s Energy Oil Market Risks," MPRA Paper 47134, University Library of Munich, Germany.
  2. Liu, Xiaochun & Jacobsen, Brian, 2011. "The Dynamic International Optimal Hedge Ratio," MPRA Paper 35260, University Library of Munich, Germany.
  3. Chang, Chiao-Yi & Lai, Jing-Yi & Chuang, I-Yuan, 2010. "Futures hedging effectiveness under the segmentation of bear/bull energy markets," Energy Economics, Elsevier, vol. 32(2), pages 442-449, March.
  4. Chang, Chia-Lin & González-Serrano, Lydia & Jimenez-Martin, Juan-Angel, 2013. "Currency hedging strategies using dynamic multivariate GARCH," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 94(C), pages 164-182.
  5. Caporin, Massimiliano & Jimenez-Martin, Juan-Angel & Gonzalez-Serrano, Lydia, 2013. "Currency hedging strategies, strategic benchmarks and the Global and Euro Sovereign financial crises," MPRA Paper 50940, University Library of Munich, Germany, revised 23 Oct 2013.

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