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European Review of Agriculture Economics Vol 29 (4) (2002) pp.471-500
© 2002 Oxford University Press and the Foundation for the European Review of Agricultural Economics

Combining time-varying and dynamic multi-period optimal hedging models

Michael S. Haigh and Matthew T. Holt

University of Maryland, College Park, MD, USA
North Carolina State University, Raleigh, NC, USA

Corresponding author: Michael S. Haigh, Department of Agricultural and Resource Economics, University of Maryland, College Park, MD 20742, USA. E-mail: mhaigh{at}arec.umd.edu

Summary

This paper presents an effective way of combining two distinct approaches used in the hedging literature—dynamic programming (DP) and time-series (GARCH) econometrics. Theoretically consistent yet realistic and tractable models are developed for traders interested in hedging a portfolio. Results from a bootstrapping experiment used to construct confidence bands around the competing portfolios suggest that, whereas DP–GARCH outperforms the GARCH approach, they are statistically equivalent to the OLS approach when the markets are stable. Traders may achieve significant gains, however, by adopting the DP–GARCH model rather than the OLS approach when markets are volatile.

Keywords: bivariate GARCH, dynamic programming, multi-period hedging


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