Currency Hedging Strategies Using Dynamic Multivariate GARCH

36 Pages Posted: 2 Nov 2011 Last revised: 14 Feb 2012

See all articles by Chia-Lin Chang

Chia-Lin Chang

National Chung Hsing University - Department of Applied Economics, Department of Finance

Lydia González Serrano

Universidad Rey Juan Carlos

Juan-Angel Jiménez-Martin

Complutense University of Madrid

Date Written: February 13, 2012

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

JEL Classification: G32, G11, G17, C53, C22

Suggested Citation

Chang, Chia-Lin and González Serrano, Lydia and Jiménez-Martin, Juan-Angel, Currency Hedging Strategies Using Dynamic Multivariate GARCH (February 13, 2012). Available at SSRN: https://ssrn.com/abstract=1952205 or http://dx.doi.org/10.2139/ssrn.1952205

Chia-Lin Chang

National Chung Hsing University - Department of Applied Economics, Department of Finance ( email )

Taichung, Taiwan
China

Lydia González Serrano

Universidad Rey Juan Carlos ( email )

Calle Tulipán, s/n
Madrid, Móstoles 28032
Spain

Juan-Angel Jiménez-Martin (Contact Author)

Complutense University of Madrid ( email )

Complutense University of Madrid
Campus de somosaguas
Pozuelo de Alarcon, Madrid 28223
Spain
+34 91 3942355 (Phone)

HOME PAGE: http://www.ucm.es/fundamentos-analisis-economico2/jajm

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