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Dynamic hedging with non-martingale futures prices and time-varying volatilities Marlowe, D. J.
Abstract
Conventional hedging theory fails to take into account a number of stylized facts about exchange rate dynamics, most importantly the time-varying nature of volatility and the cointegration between spot and futures prices. In an effort to address this, recent studies have re-examined the hedging problem using both error correction models and GARCH error structures. These studies, however, rely on the questionable assumption of martingale futures prices. This implies that a strategy of holding futures contracts should never produce a non-zero expected profit, since the expectation of any subsequent futures price will always equal today's futures price. This paper derives a hedging model which does not impose this assumption, and uses out-of-sample testing to assess its performance relative to both the timevarying martingale model and other static models. Comparisons reveal that the martingale assumption is non-trivial, and that the hedge ratios derived under this assumption will differ greatly from those derived without it. Moreover, those derived without the martingale assumption can produce a higher expected utility for the hedger under certain circumstances.
Item Metadata
Title |
Dynamic hedging with non-martingale futures prices and time-varying volatilities
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Creator | |
Publisher |
University of British Columbia
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Date Issued |
1996
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Description |
Conventional hedging theory fails to take into account a number of stylized facts about
exchange rate dynamics, most importantly the time-varying nature of volatility and the
cointegration between spot and futures prices. In an effort to address this, recent studies have re-examined the hedging problem using both error correction models and GARCH error structures. These studies, however, rely on the questionable assumption of martingale futures prices. This implies that a strategy of holding futures contracts should never produce a non-zero expected profit, since the expectation of any subsequent futures price will always
equal today's futures price. This paper derives a hedging model which does not impose this assumption, and uses out-of-sample testing to assess its performance relative to both the timevarying
martingale model and other static models. Comparisons reveal that the martingale
assumption is non-trivial, and that the hedge ratios derived under this assumption will differ greatly from those derived without it. Moreover, those derived without the martingale assumption can produce a higher expected utility for the hedger under certain circumstances.
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Extent |
3225726 bytes
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Genre | |
Type | |
File Format |
application/pdf
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Language |
eng
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Date Available |
2009-02-17
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Provider |
Vancouver : University of British Columbia Library
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Rights |
For non-commercial purposes only, such as research, private study and education. Additional conditions apply, see Terms of Use https://open.library.ubc.ca/terms_of_use.
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DOI |
10.14288/1.0087172
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URI | |
Degree | |
Program | |
Affiliation | |
Degree Grantor |
University of British Columbia
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Graduation Date |
1996-11
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Campus | |
Scholarly Level |
Graduate
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Aggregated Source Repository |
DSpace
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Item Media
Item Citations and Data
Rights
For non-commercial purposes only, such as research, private study and education. Additional conditions apply, see Terms of Use https://open.library.ubc.ca/terms_of_use.