Dynamic hedging with futures: a copula-based GARCH model with high-frequency data

Yu-Sheng Lai ()
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Yu-Sheng Lai: National Chi Nan University

Review of Derivatives Research, 2018, vol. 21, issue 3, No 3, 307-329

Abstract: Abstract Modeling the joint distribution of spot and futures returns is crucial for establishing optimal hedging strategies. This paper proposes a new class of dynamic copula-GARCH models that exploits information from high-frequency data for hedge ratio estimation. The copula theory facilitates constructing a flexible distribution; the inclusion of realized volatility measures constructed from high-frequency data enables copula forecasts to swiftly adapt to changing markets. By using data concerning equity index returns, the estimation results show that the inclusion of realized measures of volatility and correlation greatly enhances the explanatory power in the modeling. Moreover, the out-of-sample forecasting results show that the hedged portfolios constructed from the proposed model are superior to those constructed from the prevailing models in reducing the (estimated) conditional hedged portfolio variance. Finally, the economic gains from exploiting high-frequency data for estimating the hedge ratios are examined. It is found that hedgers obtain additional benefits by including high-frequency data in their hedging decisions; more risk-averse hedgers generate greater benefits.

Keywords: Dynamic copula; High-frequency data; Realized covariance; Futures hedge; Forecast comparison (search for similar items in EconPapers)
JEL-codes: C32 C53 G11 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (2)

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DOI: 10.1007/s11147-018-9142-1

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