Volatility, Correlation And Optimal Hedging

It is the volatility and correlation of spot and future market that result in the development of hedge theory. Just because of the volatility and correlation of spot and future price, the traditional naive hedge cannot reduce the risk but even increase it. In theory, an optimal hedge strategy is based on the expected-utility maximization paradigm. This paper engages academic and practical researches on the optimal hedge ratio of Chinese copper future market with the minimum-variance and minimum-LPM criterion.At the beginning of domestic future market, the market volatility regime changes frequently. In use of aboard MRS model and RCARRS model, the paper experimentally calculates the minimum-variance hedge ratio in Chinese copper future market, and compare with the OLS, ECM and dynamic-Garch models. In general, dynamic model is better than static model, whereas applicability of idiographic model depends on the state of market. Therefore, this paper adds the choice area of the optimal hedge ratio estimated model.At present, the domestic research on the tail correlation is fastened on the tail correlation of domestic and foreign market. It is rare that the research on the tail correlation of spot and future market is. The paper models the tail dependence between spot and futures returns with extreme value theory in Chinese copper market. The above-mentioned analyses indicate that the spot and futures returns on both up and down side show the asymmetric correlations character, and the correlations on the downside are much greater than on the upside.Furthermore, under the notion of loss aversion, as a measure of risk, the low partial moment is feasible to delineate the risk preference. Based on the theory of the mini-LPM hedging, the paper experimentally analyses the optimal hedge strategy of short and long position. The analytic results indicate that the hedgers who hold long positions may be more favorable than that who hold short positions in reducing downside risk.In a word, the research of this paper has following signification. On one hand, since the extreme scenarios may happen frequently in Chinese future market, the extreme correlation researches can help investor to make a decision. On the other hand, a comparative research on hedge ratio can provide some useful information for investors to choose an optimal hedge ratio estimated model.