Currency Hedging Strategies Using Dynamic Multivariate GARCH

Chia-Lin Chang (), Lydia González-Serrano and Juan Jimenez-Martin
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Lydia González-Serrano: Department of Business Administration Rey Juan Carlos University

No 2011-33, Documentos de Trabajo del ICAE from Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico

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.

Keywords: Multivariate GARCH; conditional correlations; exchange rates; optimal hedge ratio; optimal portfolio weights; hedging strategies. (search for similar items in EconPapers)
JEL-codes: C22 C53 G11 G17 G32 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2011
New Economics Papers: this item is included in nep-rmg
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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https://eprints.ucm.es/id/eprint/13815/1/1133.pdf October 2011 (application/pdf)

Related works:
Journal Article: Currency hedging strategies using dynamic multivariate GARCH (2013)
Working Paper: Currency Hedging Strategies Using Dynamic Multivariate GARCH (2012)
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