Futures Hedging Using Clusters with Dynamic Behavior of Market Fluctuation

Abstract

In this study, a novel procedure of time series dynamic behaviors clustering is proposed to improve the accuracy of minimum -variance optimal hedge ratio (OHR) estimation for future hedging. The dynamic behaviors of market fluctuation are extracted by measurement of variances, covariance, price spread, and their first and second differences. The behaviors with similar patterns are clustered using a growing hierarchical self-organizing map (GHSOM). The observations for OHR estimation are collected based on the hierarchical cluster structure and processed by within-cluster resampling. The spots and futures of the Taiwan Weighted Index (TWI) are adopted to demonstrate that the futures hedge effectiveness can be significantly improved.