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Bitcoin-based triangular arbitrage with the Euro/U.S. dollar as a foreign futures hedge: modeling with a bivariate GARCH model

1 Graduate School of Arts and Science, International Christian University, 3-10-2 Mitaka, Tokyo 181-8585, Japan
2 College of Liberal Arts, International Christian University, 3-10-2 Mitaka, Tokyo 181-8585, Japan

Special Issues: Advances in Forecasting Financial and Macroeconomic Variables Using Econometric Methods

This paper proposes a bitcoin-based triangular arbitrage, combining foreign exchanges in the bitcoin market and reverse foreign exchange spot transactions. An FX futures contract is used to reduce exposure to risk as a hedging instrument. The returns of the portfolio are jointly modeled using a bivariate DCC-GARCH model with multivariate standardized student’s t disturbances due to the presence of leptokurtosis and fat tails observed. Based on the time-dependent covariance matrix, a dynamic optimal hedge ratio is formed, with a conditional correlation series as a by-product. Empirical results are obtained using Euros and U.S. dollars over the period from 21 April 2014 to 21 September 2018. Multiple rolling one-step-ahead forecasts are generated. The empirical results present bitcoin-based currency strategies dominate bitcoin trading in terms of risk management.
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Keywords bitcoin; bitcoin exchange rate; triangular arbitrage; optimal hedge ratio; DCC-GARCH model

Citation: Zheng Nan, Taisei Kaizoji. Bitcoin-based triangular arbitrage with the Euro/U.S. dollar as a foreign futures hedge: modeling with a bivariate GARCH model. Quantitative Finance and Economics, 2019, 3(2): 347-365. doi: 10.3934/QFE.2019.2.347


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