No abstract

This article studies how the spot-futures conditional covariance matrix responds to positive and negative innovations. The main results of the article are achieved by obtaining the Volatility Impulse Response Function (VIRF) for asymmetric multivariate GARCH structures, extending Lin (1997) findings for symmetric GARCH models. This theoretical result is general and can be applied to analyze covariance dynamics in any financial system. After testing how multivariate GARCH models clean up volatility asymmetries, the Asymmetric VIRF is computed for the Spanish stock index IBEX-35 and its futures contract. The empirical results indicate that the spot-futures variance system is more sensitive to negative than positive shocks, and that spot volatility shocks have much more impact on futures volatility than vice versa. Additionally, evidence is obtained showing that optimal hedge ratios are insensitive to the well-known asymmetric volatility behavior in stock markets.

We study the profitability of trading strategies based on volatility spillovers between large and small firms. By using the Volatility Impulse-Response Function of Lin (1997) and its extensions, we detect that any volatility shock coming from small companies is important to large companies, but the reverse is only true for negative shocks coming from large firms. To exploit these asymmetric patterns in volatility, different trading rules are designed based on the inverse relationship existing between expected return and volatility. We find that most strategies generate excess after-transaction cost profits, especially after "very bad news" and "very good news" coming from large or small firm markets. These results are of special interest because of their implications for risk and portfolio management. Copyright 2007 The Authors Journal compilation (c) 2007 Blackwell Publishing Ltd.

IVIE working papers offer in advance the results of economic research under way in order to encourage a discussion process before sending them to scientific journals for their final publication. * This paper is part of a research project being carried out with FC&M, the Spanish commodity derivative exchange. Partial financial support was provided by the Institut Valencià d'Investigacions Econòmiques and the Fundación Caja de Madrid. The Instituto Nacional de Meteorología (INM) provided the data used in the study. We are also grateful for the comments and suggestions of A. Peiró, A. Pardo and J. Lucía. The usual caveat applies.

A common feature of energy prices is that spot price changes are partially predictable due to weather and demand seasonalities. This paper follows the Ederington and Salas (2008) framework and considers the expected change in spot prices when minimum variance hedge ratios are computed. The poor effectiveness of hedging strategies obtained in previous studies on electricity was because the standard hedging approach underestimates the effectiveness of hedging. In the empirical study made in this paper, weekly spot price risk is hedged with weekly futures in the Nord Pool electricity market. In this case, the optimal selection of the futures contract may produce risk reductions whose values vary between 60% and 80% -depending on the hedging duration (one to three weeks) and the analysed sub-period (in-sample and out-of-sample sub-periods).