Abstract

A dynamic hedging strategy based on a bivariate GARCH-jump model augmented with autoregressive jump intensity is proposed to manage currency risk. The GARCH-jump model, capable of capturing volatility clustering and leptokurtosis, provides a comprehensive description of the joint dynamics of the currency spot rate and the futures basis. We find significant common jump components in the currency spot rate and futures basis with jump sizes response asymmetrical to futures basis changes. Our out-of-sample hedging exercises show optimal hedge ratios incorporating information from common jump dynamics substantially reduce the portfolio risk of foreign currencies.

Recommended Citation

Wing Hong Chan (2008) "Dynamic Hedging with Foreign Currency Futures in the Presence of Jumps", Studies in Nonlinear Dynamics & Econometrics: Vol. 12: No. 2, Article 4.
http://www.bepress.com/snde/vol12/iss2/art4

Related Files

chan_datacode.zip (477 kB)
Data and code