Hedging cryptos with Bitcoin futures. Issue 5 (4th May 2023)

• Record Type: Journal Article
• Authors: Liu, Francis; Packham, Natalie; Lu, Meng-Jou; Härdle, Wolfgang Karl
• Is Part Of: Quantitative finance. Volume 23:Issue 5(2023)
• Page Start: 819
• Page End: 841
• Publication Date: 2023-05-04
• Subjects: Cryptocurrencies -- Risk management -- Hedging copulas; G11 -- G13; Finance -- Periodicals; Business mathematics -- Periodicals; Finance -- Mathematical models -- Periodicals; Investments -- Mathematics -- Periodicals; Economics -- Periodicals; Finances -- Modèles mathématiques -- Périodiques; 332.015118
• DOI: 10.1080/14697688.2023.2187316
• Languages: English
• ISSNs: 1469-7688

Abstract

Abstract : The introduction of derivatives on Bitcoin enables investors to hedge risk exposures in cryptocurrencies. Because of volatility swings and jumps in cryptocurrency prices, the traditional variance-based approach to obtain hedge ratios may not be suitable for hedgers. In this work, we consider two extensions of the traditional approach: first, different dependence structures are modelled by different copulae, such as the Gaussian, Student- t, Normal Inverse Gaussian and Archimedean copulae; second, different risk measures, such as value-at-risk, expected shortfall and spectral risk measures are employed to find the optimal hedge ratio. Extensive out-of-sample tests using the data from the time period December 2017 until May 2021 give insights in the practice of hedging various cryptos and crypto indices, including Bitcoin, Ethereum, Cardano, the CRIX index and a number of crypto-portfolios. Evidence shows that BTC futures can effectively hedge BTC and BTC-involved indices. This promising result is consistent across different risk measures and copulae except for the Frank copula. On the other hand, we observe complex and diverse dependence structures between non-BTC-related cryptocurrencies and the BTC futures. As a consequence, the hedge performance of non-BTC-related cryptocurrencies is mixed and even suitable for some assets.