Hedging with automatic liquidation and leverage selection on bitcoin futures

Carol Alexander, Jun Deng and Bin Zou

European Journal of Operational Research, 2023, vol. 306, issue 1, 478-493

Abstract: Bitcoin derivatives positions are maintained with a self-selected margin, which is often too low to avoid automatic liquidation by the exchange, without notice, especially during periods of excessive volatility. Indeed, according to CryptoQuant, almost $80 billion of positions on centralised exchanges were liquidated during 2021, that is an average of over $200 million per day. So hedgers of bitcoin price risk should account for the possibility of automatic liquidation when taking positions on bitcoin futures. We derive a semi-closed form for an optimal hedging strategy with dual objectives – to minimize both the variance of the hedged portfolio and the probability of liquidation due to insufficient collateral. The solution depends on the statistical characteristics of the spot and futures extreme returns, and other parameters that characterize the hedger by choice of leverage, loss aversion and collateral management. An empirical analysis based on minute-level data compares the performance of the major direct and inverse bitcoin hedging instruments traded on five major exchanges.

Keywords: Finance; Cryptocurrency; Leverage; Liquidation; Perpetual swap (search for similar items in EconPapers)
JEL-codes: G11 G32 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:306:y:2023:i:1:p:478-493

DOI: 10.1016/j.ejor.2022.07.037

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