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 2012-07, 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 effectiveness of using futures contracts as hedging instruments of: (1) alternative models of volatility for estimating conditional variances and covariances; (2) alternative currencies; and (3) alternative maturities of futures contracts. For this purpose, daily data of futures and spot exchange rates of three major international 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. Following Chang et al. [17], we estimate four multivariate volatility models (namely CCC, VARMA-AGARCH, DCC and BEKK), and calculate optimal portfolio weights and optimal hedge ratios to identify appropriate currency hedging strategies. The 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 empirical 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, the CCC and AGARCH models provide similar hedging effectiveness, which suggests that dynamic asymmetry may not be crucial empirically, 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: 2012, Revised 2012-02
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https://eprints.ucm.es/id/eprint/14831/1/1207.pdf (application/pdf)

Related works:
Journal Article: Currency hedging strategies using dynamic multivariate GARCH (2013)
Working Paper: Currency Hedging Strategies Using Dynamic Multivariate GARCH (2011)
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