Dynamic hedging in stock index futures via copula multiplicative error model

Abstract

This article combines a copula function and multiplicative error models to capture the dependence structure and the volatility patterns simultaneously, named copula-multiplicative error model (cMEM). We examine hedging performance of the presenting cMEM with different estimation window sizes for the futures contract of Taiwan stock price index. The results have shown that the cMEM with 1250-day window size for Clayton survival, Gumbel and OLS has better performance in which Clayton survival survives during the crisis and has the best out-of-sample hedging effectiveness. The empirical evidence indicates that the cMEM performs well for the turmoil periods.

Keywords:

• hedge ratio
• copula
• multiplicative error model
• dependence structure
• futures

JEL Classification:

• C16
• G13

Notes

¹ This article employs four types of copula functions commonly used in literature: Clayton, Clayton survival, Gumbel and Gumbel survival. For details, please see Nelsen (1999).