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Optimal Hedging with the Vector Autoregressive Model


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  • Lukasz Gatarek

    (Erasmus University Rotterdam)

  • Søren Johansen

    (University of Copenhagen, CREATES, Denmark)

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    We derive the optimal hedging ratios for a portfolio of assets driven by a Cointegrated Vector Autoregressive model with general cointegration rank. Our hedge is optimal in the sense of minimum variance portfolio. We consider a model that allows for the hedges to be cointegrated with the hedged asset and among themselves. We nd that the minimum variance hedge for assets driven by the CVAR, depends strongly on the portfolio holding period. The hedge is dened as a function of correlation and cointegration parameters. For short holding periods the correlation impact is predominant. For long horizons, the hedge ratio should overweight the cointegration parameters rather then short-run correlation information. In the innite horizon, the hedge ratios shall be equal to the cointegrating vector. The hedge ratios for any intermediate portfolio holding period should be based on the weighted average of correlation and cointegration parameters. The results are general and can be applied for any portfolio of assets that can be modeled by the CVAR of any rank and order.

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    Bibliographic Info

    Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 14-022/III.

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    Date of creation: 18 Feb 2014
    Date of revision:
    Handle: RePEc:dgr:uvatin:20140022

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    Related research

    Keywords: hedging; cointegration; minimum variance portfolio;

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    1. Dimitri Vayanos, 2004. "Flight to quality, flight to liquidity, and the pricing of risk," LSE Research Online Documents on Economics, London School of Economics and Political Science, LSE Library 456, London School of Economics and Political Science, LSE Library.
    2. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, American Finance Association, vol. 7(1), pages 77-91, 03.
    3. Phillips, P C B, 1988. "Reflections on Econometric Methodology," The Economic Record, The Economic Society of Australia, vol. 64(187), pages 344-59, December.
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