Optimal Hedging with Margin Constraints and Default Aversion and its Application to Bitcoin Perpetual Futures

41 Pages Posted: 19 Jan 2021

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: January 4, 2021

Abstract

We consider a futures hedging problem subject to a budget constraint that limits the ability of a hedger with default aversion to meet margin requirements. We derive a semi-closed form for an optimal hedging strategy with dual objectives — to minimize both the variance of the hedged portfolio and the probability of forced liquidations due to margin calls. An empirical analysis of bitcoin shows that the optimal strategy not only achieves superior hedge effectiveness, but also reduces the probability of forced liquidations to an acceptable level. We also compare how the hedger's default aversion impacts the performance of optimal hedging based on minute-level data across major bitcoin spot and perpetual futures markets.

Keywords: Cryptocurrency, Futures Hedging, Leverage, Perpetual Swap, Extreme Value Theorem

JEL Classification: G32, G11

Suggested Citation

Alexander, Carol and Deng, Jun and Zou, Bin, Optimal Hedging with Margin Constraints and Default Aversion and its Application to Bitcoin Perpetual Futures (January 4, 2021). 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.carolalexander.org

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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