Dependence Structure and Hedging of U.S. Spot and Futures Markets in Financial Crisis

Shanglei Chai

Accounting and Finance Research, 2015, vol. 4, issue 3, 77

Abstract: The main objective of this study is to measure appropriately the dependence structure and optimal hedge ratio of U.S.spot and futures markets in financial crisis. In much empirical literature it has been demonstrated that linear Pearsoncorrelation is not an appropriate dependence measure for non-normal distributions. This inadequacy of correlationrequires an appropriate dependence measure- the copula. Copula modeling has become an increasingly popular toolin finance to model assets returns dependency as it can overcome the limitations of correlation when extreme lossesoccurred. The contribution of this paper is in two aspects. First, an appropriate copula function is discovered tocapture the dependence structure of S&P 500 spot and futures in financial crisis adequately. Second, Gumbel copulafunction is exploited, with threshold GARCH model as marginals, to construct a Gumbel copula-threshold-GARCHmodel to estimate the optimal hedge ratio, simultaneously capturing asymmetric nonlinear behaviour in univariatereturns of spot and futures markets and bivariate dependency.

Date: 2015
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