Spot-Futures Spread, Time-Varying Correlation, and Hedging with Currency Futures

Journal of Futures Markets, Forthcoming

30 Pages Posted: 22 Feb 2006

See all articles by Donald D. Lien

Donald D. Lien

University of Texas at San Antonio - College of Business - Department of Economics

Li Yang

UNSW Australia Business School, School of Banking and Finance; Financial Research Network (FIRN)

Abstract

This paper investigates the effects of the spot-futures spread on the return and risk structure in currency markets. Using a bivariate dynamic conditional correlation GARCH framework, we find evidence of asymmetric effects of positive and negative spreads on the return and the risk structure of spot and futures markets. While examining the implications of the asymmetric effects on futures hedging, we compare the performance of hedging strategies generated from a model incorporating asymmetric effects with several alternative models. The in-sample comparison results indicate that the asymmetric effect model provides the best hedging strategy for all currency markets examined, except for the Canadian dollar. Out-of-sample comparisons suggest that the asymmetric effect model provides the best strategy for the Australian dollar, the British pound, the Deutsche mark, and the Swiss franc markets, while the symmetric effect model provides a better strategy than the asymmetric effect model in the Canadian dollar and the Japanese yen. The worst performance is given by the naive hedging strategy for both in-sample and out-of-sample comparisons in all currency markets examined.

Keywords: Asymmetric effects of spot-futures spread, Dynamic conditional correlation, Currency futures hedging, GARCH specification

JEL Classification: C13, C32, G13

Suggested Citation

Lien, Donald and Yang, Li, Spot-Futures Spread, Time-Varying Correlation, and Hedging with Currency Futures. Journal of Futures Markets, Forthcoming. Available at SSRN: https://ssrn.com/abstract=881426

Donald Lien

University of Texas at San Antonio - College of Business - Department of Economics ( email )

6900 North Loop 1604 West
San Antonio, TX 78249
United States
210-458-4313 (Phone)
210-458-4308 (Fax)

Li Yang (Contact Author)

UNSW Australia Business School, School of Banking and Finance ( email )

Sydney, NSW 2052
Australia
+610293855857 (Phone)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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