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Conditional volatility forecasting in a dynamic hedging model

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  • Michael S. Haigh

    (US Commodity Futures Trading Commission and University of Maryland, USA)

Abstract

This paper addresses several questions surrounding volatility forecasting and its use in the estimation of optimal hedging ratios. Specifically: Are there economic gains by nesting time-series econometric models (GARCH) and dynamic programming models (therefore forecasting volatility several periods out) in the estimation of hedging ratios whilst accounting for volatility in the futures bid-ask spread? Are the forecasted hedging ratios (and wealth generated) from the nested bid-ask model statistically and economically different than standard approaches? Are there times when a trader following a basic model that does not forecast outperforms a trader using the nested bid-ask model? On all counts the results are encouraging-a trader that accounts for the bid-ask spread and forecasts volatility several periods in the nested model will incur lower transactions costs and gain significantly when the market suddenly and abruptly turns. Copyright © 2005 John Wiley & Sons, Ltd.

Suggested Citation

  • Michael S. Haigh, 2005. "Conditional volatility forecasting in a dynamic hedging model," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 24(3), pages 155-172.
    • Handle: RePEc:jof:jforec:v:24:y:2005:i:3:p:155-172
    DOI: 10.1002/for.950
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    References listed on IDEAS

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    Cited by:

    1. Aleksander Olstad & George Filis & Stavros Degiannakis, 2021. "Oil and currency volatilities: Co‐movements and hedging opportunities," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 26(2), pages 2351-2374, April.

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