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

• Main Authors: Zheng Nan, Taisei Kaizoji
• Format: Article
• Language: English
• Published: AIMS Press 2019-06-01
• Series: Quantitative Finance and Economics
• Subjects: bitcoin| bitcoin exchange rate| triangular arbitrage| optimal hedge ratio| DCC-GARCH model
• Online Access: https://www.aimspress.com/article/10.3934/QFE.2019.2.347/fulltext.html

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.