Hedging with Automatic Liquidation and Leverage Selection on Bitcoin Futures

30 Pages Posted: 19 Jan 2021 Last revised: 22 Apr 2022

See all articles by Carol Alexander

Carol Alexander

University of Sussex Business School; Peking University HSBC Business School

Jun Deng

University of International Business and Economics (UIBE) - School of Banking and Finance

Bin Zou

University of Connecticut - Department of Mathematics

Date Written: Februrary 22, 2022

Abstract

We consider the hedging problem where a futures position can be automatically liquidated by the
exchange without notice. We derive a semi-closed form for an optimal hedging strategy with dual
objectives -- to minimise both the variance of the hedged portfolio and the probability of liquidations
due to insufficient collateral. The optimal solution depends on the statistical characteristics of the spot and futures extreme returns and parameters that characterise the hedger by loss aversion, choice of leverage and collateral management. An empirical analysis of bitcoin shows that the optimal strategy combines superior hedge effectiveness with a reduction in the probability of liquidation. We compare the performance of seven major direct and inverse hedging instruments traded on five different exchanges, based on minute-level data. We also link this performance to novel speculative trading metrics, which differ markedly between venues.

Keywords: Cryptocurrency; Leverage; Liquidation; Perpetual Swap; Extreme Value Theorem

JEL Classification: G32, G11

Suggested Citation

Alexander, Carol and Deng, Jun and Zou, Bin, Hedging with Automatic Liquidation and Leverage Selection on Bitcoin Futures (Februrary 22, 2022). Available at SSRN: https://ssrn.com/abstract=3760048 or http://dx.doi.org/10.2139/ssrn.3760048

Carol Alexander

University of Sussex Business School ( email )

Falmer, Brighton BN1 9SL
United Kingdom

HOME PAGE: http://www.coalexander.com

Peking University HSBC Business School ( email )

Jun Deng

University of International Business and Economics (UIBE) - School of Banking and Finance ( email )

No.10, Huixindong Street
Chaoyang District
Beijing, 100029
China

Bin Zou (Contact Author)

University of Connecticut - Department of Mathematics ( email )

341 Mansfield Road U1009
Department of Mathematics
Storrs, CT 06269-1069
United States

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