Optimal Dynamic Hedging via Copula-Threshold-GARCH Models

24 Pages Posted: 27 May 2009

See all articles by YiHao Lai

YiHao Lai

Department of Finance, Da-Yeh University

Cathy W. S. Chen

Feng Chia University - Department of Statistics; Graduate Institute of Statistics & Actuarial Science, Feng Chia University

Richard H. Gerlach

University of Sydney

Date Written: May 27, 2009

Abstract

The contribution of this paper is twofold. First, we exploit copula methodology, with two threshold GARCH models as marginals, to construct a bivariate copula threshold GARCH model, simultaneously capturing asymmetric nonlinear behaviour in univariate stock returns of spot and futures markets and bivariate dependency, in a flexible manner. Two elliptical copulas (Gaussian and Student-t) and three Archimedean copulas (Clayton, Gumbel and the Mixture of Clayton and Gumbel) are utilized. Secondly, we employ the presenting models to investigate the hedging performance for five East Asian spot and futures stock markets: Hong Kong, Japan, Korea, Singapore and Taiwan. Compared with conventional hedging strategies, including Engle’s dynamic conditional correlation GARCH model, the results show that hedge ratios constructed by a Gaussian or Mixture copula are the best-performed in variance reduction for all markets except Japan and Singapore, and provide close to the best returns on a hedging portfolio over the sample period.

Keywords: hedge ratio, threshold GARCH, copula, spot and futures market, stock return

JEL Classification: C50, D81, G15

Suggested Citation

Lai, YiHao and Chen, Cathy W. S. and Gerlach, Richard H., Optimal Dynamic Hedging via Copula-Threshold-GARCH Models (May 27, 2009). Available at SSRN: https://ssrn.com/abstract=1410558 or http://dx.doi.org/10.2139/ssrn.1410558

YiHao Lai

Department of Finance, Da-Yeh University ( email )

112 Shan-Jiau Rd., Da-Tsuen
Chang-Hua 515, Taiwan 515
China

Cathy W. S. Chen

Feng Chia University - Department of Statistics ( email )

100 Wen Hwa Road
Taichung, 407
Taiwan
886 4 24517250 ext 4412 (Phone)
886 4 24517092 (Fax)

HOME PAGE: http://myweb.fcu.edu.tw/~chenws/

Graduate Institute of Statistics & Actuarial Science, Feng Chia University

100 Wenhwa Road
Talchung
Taiwan
886 4-24517250 ext 4412 (Phone)
886 4-2517092 (Fax)

HOME PAGE: http://myweb.fcu.edu.tw/~chenws/

Richard H. Gerlach (Contact Author)

University of Sydney ( email )

Room 483, Building H04
University of Sydney
Sydney, NSW 2006
Australia
+ 612 9351 3944 (Phone)
+ 612 9351 6409 (Fax)

HOME PAGE: http://www.econ.usyd.edu.au/staff/richardg

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