Time–frequency domain based optimization of hedging strategy: Evidence from CSI 500 spot and futures

Abstract

Considering the significance of the frequency domain information in price series, we propose a decomposition-integration hedging model from the perspective of time–frequency domain to improve the hedging effectiveness and robustness. First, the returns series of spot and futures are decomposed and reconstructed into high frequency, medium frequency, and low frequency sequences to incorporate the frequency information into the hedging model. Then, we construct a model pool to fit the various characteristics of the data in each frequency domain and further extract the corresponding information. Finally, by taking four moments of investors risk appetite into consideration, the multi-objective optimization is employed to integrate the final hedging ratio. The empirical results indicate that the decomposition-integration hedging model is superior to the single time domain models in comprehensive evaluation indices. In addition, within a certain range of market fluctuations, the structure of our model has some characteristics that are compatible with reality. To recapitulate briefly, the hedging ratio of our model is mainly determined by the high frequency and medium frequency information under drastic market fluctuations. While when the market volatility is small, the hedging ratio largely depends on low frequency information.