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Currency Hedging Strategies Using Dynamic Multivariate GARCH

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Abstract

This paper examines the effect on the effectiveness of using futures contracts as hedging instruments of: 1) the model of volatility used to estimate conditional variances and covariances, 2) the analyzed currency, and 3) the maturity of the futures contract being used. For this purpose, daily data of futures and spot exchange rates of three 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 (CCC, VARMA-AGARCH, DCC and BEKK) and calculate optimal portfolio weights and optimal hedge ratios to identify appropriate currency hedging strategies. 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 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, CCC and AGARCH models provide similar hedging effectiveness although some differences appear when the DCC and BEKK models are used.

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Bibliographic Info

Paper provided by Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico in its series Documentos de Trabajo del ICAE with number 2011-33.

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Length: 36 pages
Date of creation: 2011
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Handle: RePEc:ucm:doicae:1133

Note: The authors are most grateful for the helpful comments and suggestions of participants at the International Conference on Risk Modelling and Management, Madrid, Spain, June 2011, especially to M. McAleer and T. Pérez Amaral. The second author acknowledges the financial support of the Ministerio de Ciencia y Tecnología and Comunidad de Madrid, Spain.
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Keywords: Multivariate GARCH; conditional correlations; exchange rates; optimal hedge ratio; optimal portfolio weights; hedging strategies.;

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References

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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," Tinbergen Institute Discussion Papers 13-085/III, Tinbergen Institute, revised 08 Jul 2013.
  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.Ð’., 2014. "Построение Коэффициентов Хеджирования Для Высоколиквидных Акций Российского Рынка На Основе Моделей КлассÐ," Журнал Экономика и математические методы (ЭММ), Центральный Экономико-Математический Институт (ЦЭМИ), Центральный Экономико-Математический Институт (ЦЭМИ), vol. 50(1), pages 37-54, янваÑ.

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