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Currency Hedging Strategies Using Dynamic Multivariate GARCH

González-Serrano, Lydia and Jiménez-Martín, Juan-Ángel (2011) Currency Hedging Strategies Using Dynamic Multivariate GARCH. [Working Paper or Technical Report] (Unpublished)

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Abstract

This paper examines the effect on the effectiveness of using futures contracts as hedging instruments of: 1) the model of volatility used to estimate conditional variances and covariances, 2) the analyzed currency, and 3) the maturity of the futures contract being used. For this purpose, daily data of futures and spot exchange rates of three 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 Tansuchat, Chang and McAleer (2010), we estimate four multivariate volatility models (CCC, VARMA-AGARCH, DCC and BEKK) and calculate optimal portfolio weights and optimal hedge ratios to identify appropriate currency hedging strategies. 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 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, CCC and AGARCH models provide similar hedging effectiveness although some differences appear when the DCC and BEKK models are used.

Item Type:Working Paper or Technical Report
Additional Information:JEL Classifications: G32, G11, G17, C53, C22. The authors are most grateful for the helpful comments and suggestions of participants at the International Conference on Risk Modelling and Management, Madrid, Spain, June 2011, especially to M. McAleer and T. Pérez Amaral. The second author acknowledges the financial support of the Ministerio de Ciencia y Tecnología and Comunidad de Madrid, Spain.
Uncontrolled Keywords:Multivariate GARCH, conditional correlations, exchange rates, optimal hedge ratio, optimal portfolio weights, hedging strategies.
Subjects:Social sciences > Economics > Econometrics
Series Name:Documentos de trabajo del Instituto Complutense de Análisis Económico
Volume:2011
Number:33
ID Code:13815
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Last Modified:15 Nov 2013 10:49

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