Hedging with Bitcoin Futures: The Effect of Liquidation Loss Aversion\n and Aggressive Trading

Abstract

We consider the hedging problem where a futures position can be automatically\nliquidated by the exchange without notice. We derive a semi-closed form for an\noptimal hedging strategy with dual objectives - to minimise both the variance\nof the hedged portfolio and the probability of liquidations due to insufficient\ncollateral. The optimal solution depends on the statistical characteristics of\nthe spot and futures extreme returns and parameters that characterise the\nhedger by loss aversion, choice of leverage and collateral management. An\nempirical analysis of bitcoin shows that the optimal strategy combines superior\nhedge effectiveness with a reduction in the probability of liquidation. We\ncompare the performance of seven major direct and inverse hedging instruments\ntraded on five different exchanges, based on minute-level data. We also link\nthis performance to novel speculative trading metrics, which differ markedly\nbetween venues.\n