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Dynamic Hedging with Foreign Currency Futures in the Presence of Jumps

Listed author(s):
  • Chan Wing Hong

    ()

    (City University of Hong Kong)

A dynamic hedging strategy based on a bivariate GARCH-jump model augmented with autoregressive jump intensity is proposed to manage currency risk. The GARCH-jump model, capable of capturing volatility clustering and leptokurtosis, provides a comprehensive description of the joint dynamics of the currency spot rate and the futures basis. We find significant common jump components in the currency spot rate and futures basis with jump sizes response asymmetrical to futures basis changes. Our out-of-sample hedging exercises show optimal hedge ratios incorporating information from common jump dynamics substantially reduce the portfolio risk of foreign currencies.

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File URL: https://www.degruyter.com/view/j/snde.2008.12.2/snde.2008.12.2.1571/snde.2008.12.2.1571.xml?format=INT
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Article provided by De Gruyter in its journal Studies in Nonlinear Dynamics & Econometrics.

Volume (Year): 12 (2008)
Issue (Month): 2 (May)
Pages: 1-25

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Handle: RePEc:bpj:sndecm:v:12:y:2008:i:2:n:4
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References listed on IDEAS
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  1. Drost, Feike C & Nijman, Theo E & Werker, Bas J M, 1998. "Estimation and Testing in Models Containing Both Jump and Conditional Heteroscedasticity," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(2), pages 237-243, April.
  2. Carolyn W. Chang & Jack S.K. Chang & Hsing Fang, 1996. "Optimum futures hedges with jump risk and stochastic basis," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 16(4), pages 441-458, 06.
  3. Pan, Jun, 2002. "The jump-risk premia implicit in options: evidence from an integrated time-series study," Journal of Financial Economics, Elsevier, vol. 63(1), pages 3-50, January.
  4. Jun Liu, 2005. "An Equilibrium Model of Rare-Event Premia and Its Implication for Option Smirks," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 131-164.
  5. Wing H. Chan, 2003. "A correlated bivariate Poisson jump model for foreign exchange," Empirical Economics, Springer, vol. 28(4), pages 669-685, November.
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