Macroeconomic Volatility : Dynamic Futures Hedging Strategies

Economic instability in emerging countries has often been attributed to countercyclical fiscal policy. The problem is further exacerbated by income volatility caused by international commodity price fluctuations, while directional hedging, as a favourite policy response, has been both costly and ineffective. We propose efficient and effective volatility hedging strategies for emerging countries in a dynamic stochastic setting based upon partial portfolio optimisation. Our first contribution is a dynamic overlay futures hedging strategy with substantial reduction in hedging cost. Second, we account for stochastic volatility in commodity prices by adopting GARCH and Error Correction Methods (ECM) to improve the forecasting accuracy of dynamic hedge ratios. Thirdly, we account for non-linear dependence in the pairwise combinations of the bivariate spot and futures sample data by employing Archimedian Copula models to estimate dynamic hedge ratios used for the state-contingent dynamic overlay sovereign hedging strategies. Finally, we combine GARCH and dynamic Copula models for the estimation of dynamic-Copula-GARCH hedge ratios that significantly improve hedge efficiency