Hedging Based On Dynamic Correlation And Avoiding Exchange Risk

In economical globalization, Foreign exchange risk that enterprises face increases due to exchange rate fluctuations and enterprises' global supply chain, so it's urgent for enterprises to find effective methods to avoid exchange rate risk. Using of financial derivatives to hedge for risks attracts more and more attention for its excellent effect. The most important part of hedging strategy is to estimate optimal hedging ratio, although the estimation methods have been developed from the linear model to the nonlinear model, but it hasn't significantly improved hedging effectiveness in practice.On the basis of the portfolio theory, this paper redefines hedging as a portfolio investment on the spot and futures and concludes that optimal hedging ratio in the minimization of income risk is relevant to the correlation between spot and futures' yield which is changed over time through the rolling correlation estimation. Therefore, this paper proposes a new estimation method of optimal hedging ratio, which is based on the dynamic correlation, uses the Dynamic Conditional Correlation (DCC) model that can estimate the time-varying conditional correlation coefficients of spot and futures' yield, so that it can improve the precision of the optimal hedging ratio, and enhance the hedging effectiveness.This paper designs two empirical researches, the direct-hedging and the cross-hedging, for helping Chinese enterprises avoid foreign exchange risk in future and at present. The direct-hedging research is a traditional one that uses one foreign exchange futures hedging for one foreign exchange spot, and the cross-hedging research is one that uses one foreign exchange futures hedging for many foreign exchange spots. By comparing different estimation methods, this paper finds that the new estimation method of optimal hedging ratio, which is based on the dynamic correlation, is better than other methods.In addition, the estimation method of optimal hedging ratio in this paper can be used not only in the foreign exchange futures, but in other financial derivatives.