The Role of the Bid-Ask Spread in a Dynamic - Time-Varying Optimal Hedging Model

Michael S. Haigh

No 18967, 2001 Conference, April 23-24, 2001, St. Louis, Missouri from NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management

Abstract: This paper presents a manageable and effective way of nesting two popular, yet distinct approaches to obtain optimal hedging ratios - time-series econometrics (GARCH) and dynamic programming (DP). The nested DP-GARCH model is then compared to a DP-GARCH model that accounts for variability in the bid-ask spread often unobserved (and hence ignored) in most studies. Results from an empirical application using data from an importantly traded commodity " sugar " suggest that a DP-GARCH model that incorporates the bid-ask spread still outperforms more traditional models. Moreover, the hedging ratios are far less volatile, and statistically different, than those recommended by the traditional GARCH methods that ignore the spread.

Keywords: Marketing (search for similar items in EconPapers)
Pages: 33
Date: 2001
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Persistent link: https://EconPapers.repec.org/RePEc:ags:ncrone:18967

DOI: 10.22004/ag.econ.18967

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