Optimal Commodity and Cross-Currency Heding: The Case of Asean-5-Based Grain and Soft Commodity Traders

Abstract

The changes in commodity prices and exchange rates leave the representative ASEAN-5-based international commodity traders exposed with multiple risks. Foreign exchange hedging ratios are simultaneously estimated alongside commodity ratios in a time-varying portfolio framework. The comparisons of the minimum variance hedge ratios (MVHR) performance reveal that the model with the time-varying variance-covariance matrix provides greater risk reduction than the conventional model, illustrating importance of time-varying variance-covariance effect when modeling joint dynamic of spot and futures returns and hence estimating hedging strategies. When transaction costs are taken into account, incorporating Student’s t significantly enhances the performance of dynamic strategies in wheat and soybeans markets. However, the conventional OLS shows superior performance in the cotton market in terms of utility gain.