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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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Bibliographic Info

Article provided by Taylor and 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. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-31, February.
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  4. Bollerslev, Tim & Engle, Robert F, 1993. "Common Persistence in Conditional Variances," Econometrica, Econometric Society, vol. 61(1), pages 167-86, January.
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  11. 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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  14. McCurdy, Thomas H & Morgan, Ieuan G, 1988. "Testing the Martingale Hypothesis in Deutsche Mark Futures with Models Specifying the Form of Heteroscedasticity," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 3(3), pages 187-202, July-Sept.
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  17. Baillie, Richard T & Myers, Robert J, 1991. "Bivariate GARCH Estimation of the Optimal Commodity Futures Hedge," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 6(2), pages 109-24, April-Jun.
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Cited by:
  1. Chia-Lin Chang & Lydia González-Serrano & Juan-Ángel Jiménez-Martín, 2012. "Currency Hedging Strategies Using Dynamic Multivariate GARCH," Documentos del Instituto Complutense de Análisis Económico 2012-07, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, revised Feb 2012.
  2. 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.
  3. Liu, Xiaochun & Jacobsen, Brian, 2011. "The Dynamic International Optimal Hedge Ratio," MPRA Paper 35260, University Library of Munich, Germany.

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