Estimating Optimal Hedge Ratio and Hedge Effectiveness via Fitting the Multivariate Skewed Distributions

This paper introduces the use of three multivariate skew distributions (Generalized Hyperbolic distribution, multivariate skew normal distribution, and multivariate skew t distribution) for estimating the minimum variance hedge ratio in a dynamic setting. Three criteria for measuring hedge effectiveness are employed: Hedging Instrument Effectiveness, Overall Hedge Effectiveness, and Relative-to-Optimal Hedge Ratio Effectiveness. The empirical analysis outcomes confirm that the three multivariate skew distributions are instrumental in deciding the optimal hedge ratio, and especially at the critical market moments because they consider both hedge and speculation as shown by Relative-to-Optimal Hedge Ratio Effectiveness criterion. This advantage is held without the price of lower portfolio return. The traditional minimum variance hedge ratio can function as an effective hedge but will only keep the portfolio variance at its minimum level