The Shape of the Optimal Hedge Ratio: Modeling Joint Spot-Futures Prices using an Empirical Copula-GARCH Model
Commodity cash and futures prices have been rising steadily since 2006. As evidenced by the April 2008 Commodity Futures Trading Commission Agricultural Forum, there is much concern among traditional futures and options market participants that the usefulness of commodity derivatives has been compromised. When basis risk is particularly high, dynamic hedging methods may be helpful despite their complexity and higher transaction costs. To assess the potential benefits of dynamic hedging in volatile times, this paper proposes a novel, empirical copula-based method to estimate GARCH models and to compute time-varying hedge ratios. This approach allows a nonlinear, asymmetric dependence structure between cash and futures prices. The paper addresses four principal questions: (1) Does the empirical copula-GARCH method overcome traditional limitations of dynamic hedging methods? (2) How does the empirical copula- GARCH hedging approach perform, for storable agricultural commodities, compared with traditional GARCH and Minimum Variance (static) hedging methods? (3) Is dynamic hedging more or less effective in the post-2006 biofuels expansion time period? (4) How sensitive is the ranking of methods to the hedging effectiveness criterion used? Preliminary findings suggest that the empirical copula-GARCH approach leads to superior hedging effectiveness based on some, but not all, risk criteria.
|Date of creation:||2008|
|Contact details of provider:|| Postal: 326 Mumford Hall, MC-710, 1301 West Gregory Drive, Urbana, Illinois, 61801|
Phone: (217) 333-1810
Fax: (217) 333-5538
Web page: http://www.farmdoc.uiuc.edu/nccc134/
More information through EDIRC
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Dorfman, Jeffrey H. & Sanders, Dwight R., 2004.
"Generalized Hedge Ratio Estimation With An Unknown Model,"
2004 Conference, April 19-20, 2004, St. Louis, Missouri
19024, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
- Dorfman, Jeffrey H. & Sanders, Dwight R., 2005. "Generalized Hedge Ratio Estimation with an Unknown Model," 2005 Annual meeting, July 24-27, Providence, RI 19268, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
- John Cotter & Jim Hanly, 2006. "Reevaluating hedging performance," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 26(7), pages 677-702, 07.
- Cotter, John & Hanly, James, 2005. "Re-evaluating Hedging Performance," MPRA Paper 3523, University Library of Munich, Germany.
- John Cotter & Jim Hanly, 2011. "Re-evaluating Hedging Performance," Working Papers 200518, Geary Institute, University College Dublin.
- Lien, Donald, 2005. "The use and abuse of the hedging effectiveness measure," International Review of Financial Analysis, Elsevier, vol. 14(2), pages 277-282.
- Moschini, GianCarlo & Myers, Robert J., 2002. "Testing for constant hedge ratios in commodity markets: a multivariate GARCH approach," Journal of Empirical Finance, Elsevier, vol. 9(5), pages 589-603, December.
- GianCarlo Moschini & Robert J. Myers, 2001. "Testing for Constant Hedge Ratios in Commodity Markets: A Multivariate GARCH Approach," Center for Agricultural and Rural Development (CARD) Publications 01-wp268, Center for Agricultural and Rural Development (CARD) at Iowa State University.
- Moschini, GianCarlo & Myers, Robert J., 2002. "Testing for Constant Hedge Ratios in Commodity Markets: A Multivariate Garch Approach," Staff General Research Papers Archive 1945, Iowa State University, Department of Economics.
- Lence, Sergio H & Hayes, Dermot J, 1994. " Parameter-Based Decision Making under Estimation Risk: An Application to Futures Trading," Journal of Finance, American Finance Association, vol. 49(1), pages 345-357, March.
- Lence, Sergio H. & Hayes, Dermot J., 1994. "Parameter-Based Decision Making Under Estimation Risk: An Application to Futures Trading," Staff General Research Papers Archive 693, Iowa State University, Department of Economics.
- Mattos, Fabio & Garcia, Philip & Nelson, Carl, 2008. "Relaxing standard hedging assumptions in the presence of downside risk," The Quarterly Review of Economics and Finance, Elsevier, vol. 48(1), pages 78-93, February.
- Mattos, Fabio & Garcia, Philip & Nelson, Carl H., 2005. "Relaxing Standard Hedging Assumptions in the Presence of Downside Risk," 2005 Conference, April 18-19, 2005, St. Louis, Missouri 19040, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
- Ted C. Schroeder & Marvin L. Hayenga, 1988. "Comparison of selective hedging and options strategies in cattle feedlot risk management," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 8(2), pages 141-156, 04.
- Hayenga, Marvin L. & Schroeder, Ted C., 1988. "Comparison of Selective Hedging and Option Strategies in Cattle Feed Lot Risk Management," Staff General Research Papers Archive 11313, Iowa State University, Department of Economics.
- Sébastien Laurent & Luc Bauwens & Jeroen V. K. Rombouts, 2006. "Multivariate GARCH models: a survey," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(1), pages 79-109.
- BAUWENS, Luc & LAURENT, Sébastien & ROMBOUTS, Jeroen VK, "undated". "Multivariate GARCH models: a survey," CORE Discussion Papers RP 1847, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- BAUWENS, Luc & LAURENT, Sébastien & ROMBOUTS, Jeroen, 2003. "Multivariate GARCH models: a survey," CORE Discussion Papers 2003031, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Calum G. Turvey & Timothy G. Baker, 1989. "Optimal Hedging under Alternative Capital Structures and Risk Aversion," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 37(1), pages 135-143, 03.
- Cecchetti, Stephen G & Cumby, Robert E & Figlewski, Stephen, 1988. "Estimation of the Optimal Futures Hedge," The Review of Economics and Statistics, MIT Press, vol. 70(4), pages 623-630, November.
- Stephen G. Cecchetti & Robert E. Cumby & Stephen Figlewski, 1986. "Estimation of the optimal futures hedge," Research Working Paper 86-10, Federal Reserve Bank of Kansas City.
- Lee, Tae-Hwy & Long, Xiangdong, 2009. "Copula-based multivariate GARCH model with uncorrelated dependent errors," Journal of Econometrics, Elsevier, vol. 150(2), pages 207-218, June.
- Sergio H. Lence & Dermot J. Hayes, 1993. "Empirical Minimum Variance Hedge, The," Center for Agricultural and Rural Development (CARD) Publications 93-wp109, Center for Agricultural and Rural Development (CARD) at Iowa State University.
- Lence, Sergio H. & Hayes, Dermot J., 1994. "Empirical Minimum-Variance Hedge (The)," Staff General Research Papers Archive 11565, Iowa State University, Department of Economics.
- B. Wade Brorsen, 1995. "Optimal Hedge Ratios with Risk-Neutral Producers and Nonlinear Borrowing Costs," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 77(1), pages 174-181.
- Haigh, Michael S. & Holt, Matthew T., 2002. "Hedging Foreign Currency, Freight And Commodity Futures Portfolios: A Note," Working Papers 28573, University of Maryland, Department of Agricultural and Resource Economics.
- Ibragimov, Rustam, 2009. "Copula-Based Characterizations For Higher Order Markov Processes," Econometric Theory, Cambridge University Press, vol. 25(03), pages 819-846, June.
- Viviana Fernandez, 2008. "Multi‐period hedge ratios for a multi‐asset portfolio when accounting for returns co‐movement," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 28(2), pages 182-207, 02.
- Viviana Fernández, 2007. "Multi-period hedge ratios for a multi-asset portfolio when accounting for returns comovement," Documentos de Trabajo 242, Centro de Economía Aplicada, Universidad de Chile.
- Myers, Robert J. & Thompson, Stanley R., 1988. "Generalized Optimal Hedge Ratio Estimation," Staff Papers 200967, Michigan State University, Department of Agricultural, Food, and Resource Economics.
- Anil K. Bera & Philip Garcia & Jae-Sun Roh, 1997. "Estimation of Time-Varying Hedge Ratios for Corn and Soybeans: BGARCH and Random Coefficient Approaches," Finance 9712007, EconWPA.
- Isabelle Huault & V. Perret & S. Charreire-Petit, 2007. "Management," Post-Print halshs-00337676, HAL.
- Chen, Xiaohong & Fan, Yanqin, 2006. "Estimation and model selection of semiparametric copula-based multivariate dynamic models under copula misspecification," Journal of Econometrics, Elsevier, vol. 135(1-2), pages 125-154.
- Michael S. Haigh & Matthew T. Holt, 2000. "Hedging Multiple Price Uncertainty in International Grain Trade," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 82(4), pages 881-896.
- Jondeau, Eric & Rockinger, Michael, 2006. "The Copula-GARCH model of conditional dependencies: An international stock market application," Journal of International Money and Finance, Elsevier, vol. 25(5), pages 827-853, August.
- Granger, Clive W.J. & Terasvirta, Timo & Patton, Andrew J., 2006. "Common factors in conditional distributions for bivariate time series," Journal of Econometrics, Elsevier, vol. 132(1), pages 43-57, May.
- Timo Terasvirta & Clive W.J Granger & Andrew Patton, 2003. "Common factors in conditional distributions for Bivariate time series," FMG Discussion Papers dp455, Financial Markets Group.
- Kole, Erik & Koedijk, Kees & Verbeek, Marno, 2007. "Selecting copulas for risk management," Journal of Banking & Finance, Elsevier, vol. 31(8), pages 2405-2423, August.
- Koedijk, Kees & Kole, Erik & Verbeek, Marno, 2006. "Selecting Copulas for Risk Management," CEPR Discussion Papers 5652, C.E.P.R. Discussion Papers.
- Sanders, Dwight R. & Manfredo, Mark R., 2004. "Comparing Hedging Effectiveness: An Application of the Encompassing Principle," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 29(01), April.
- Bartram, Sohnke M. & Taylor, Stephen J. & Wang, Yaw-Huei, 2007. "The Euro and European financial market dependence," Journal of Banking & Finance, Elsevier, vol. 31(5), pages 1461-1481, May. Full references (including those not matched with items on IDEAS)
When requesting a correction, please mention this item's handle: RePEc:ags:nccest:37609. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (AgEcon Search)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.