Title: Minimum variance hedging when using implied covariances
Authors: Andres Algaba - Vrije Universiteit Brussel (Belgium) [presenting]
Kris Boudt - Vrije Universiteit Brussel and VU Amsterdam (Belgium)
Steven Vanduffel - Vrije Universiteit Brussel (Belgium)
Abstract: The minimum variance hedge ratio is defined as the ratio of the conditional covariance between spot and futures returns to the conditional variance of futures returns. We recommend to imply the conditional covariance from the conditional variance of the weighted sum of spot and futures returns to avoid the modelling restrictions and computational challenges in estimating traditional BGARCH models. An optimal weight can be derived by minimizing the scaled variance of the sample variance estimator of this weighted sum. In a simulated and empirical application, we find that our approach performs as well as BGARCH models.