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Spring 2022 Actuarial Science and Financial Mathematics Seminar: Hedging with Automatic Liquidation and Leverage Selection on Bitcoin Futures

Event Type
wifi event
Mar 18, 2022   3:00 - 4:00 pm  
Bin Zou (University of Connecticut)
Frank Quan

Meeting ID: 792 221 9559
Password: 043910

Abstract: Bitcoin derivatives positions are maintained with a self-selected margin, often too low to avoid liquidation by the exchange, without notice, during periods of excessive volatility. Recently, the size and scale of such liquidations precipitated extreme discontent among traders and numerous lawsuits against exchanges. Clearly, hedgers of bitcoin should account for the possibility of automatic liquidation. That is the mathematical and operational problem that we address, deriving a semi-closed form for an optimal hedging strategy with dual objectives – to minimize both the variance of the hedged portfolio and the probability of liquidation due to insufficient collateral. An empirical analysis based on minute-level data compares the performance of major direct and inverse bitcoin hedging instruments traded on five major exchanges. The products have markedly different speculative trading scores according to new metrics introduced here. Instruments having similar hedging effectiveness can exhibit marked differences in speculative activity. Inverse perpetuals offer greater effectiveness than direct perpetuals, which also exhibit more speculation. We model hedgers with different levels of loss aversion that select their own level of leverage and collateral in the margin account. By following the optimal strategy, the hedger can reduce the liquidation probability to less than 1% and control leverage to a reasonable level, mostly below 5X.

Based on a joint work with Carol Alexander (University of Sussex) and Jun Deng (University of International Business and Economics).

About: Bin Zou is currently an assistant professor in the Department of Mathematics at the University of Connecticut. Prior to joining UConn in 2017, he was an acting assistant professor at the University of Washington from 2016/9 to 2017/8 and a postdoctoral fellow at the Technical University of Munich from 2015/5 to 2016/8. He obtained his PhD in Mathematical Finance from the University of Alberta in 2015. His main research interests are stochastic control and optimization, with applications in actuarial science and financial mathematics, and recent interests include cryptocurrency markets and sports betting. Please visit his website for more information:

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