Exchange rate volatility and time varying hedge ratios

Abstract

Conventional approaches to hedging with commodities and fascial futures so that the optimal hedge ratio in time invariant However, if the distributions of spot and futures prices are changing through time then estimating a constant hedge ratio may not be appropriate, and an estimation procedure which counts for the changing distribution must be used. In this paper we verify that the conditional bivariate distribution of the Japanese you spot and futures prices is not constant, and propose a simple dynamic hedging model which minimizes exchange risk in the yen. The optimal hedge from his motel function of time varying conditional second moments of the sent and futures price distribution, and is therefore varying itself. We then estimate the time varying hedge ratio ga bivariate generalized autoregressive conditional heteroskedasticity (ARCH) model and compare the performance of our time varying hedge the performance of the conventional constant hedge. Within ample comparisons reveal that our proposed dynamic hedge performs better than the conventional hedge, while out of sample tests give mixed result.