Regime switching correlation hedging

This paper investigates the hedging effectiveness of commodity futures when the correlations of spot and futures returns are subject to multi-state regime shifts. An independent switching dynamic conditional correlation GARCH ( IS-DCC) which is free from the problems of path-dependency and recombini...

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Bibliographic Details
Published inJournal of banking & finance Vol. 34; no. 11; pp. 2728 - 2741
Main Author Lee, Hsiang-Tai
Format Journal Article
LanguageEnglish
Published Amsterdam Elsevier B.V 01.11.2010
Elsevier
Elsevier Sequoia S.A
SeriesJournal of Banking & Finance
Subjects
ARCH-Modell
Capital market
Commodity futures
Correlation
Correlation analysis
Correlation hedging
Correlation hedging Minimum variance hedge ratio GARCH model Markov regime switching Commodity futures
Effectiveness studies
Financial institutions
Financial services
GARCH model
GARCH models
Hedging
Korrelation
Markov regime switching
Minimum variance hedge ratio
Rates of return
Stochastic models
Minimum variance hedge ratio
C32
G13
Correlation hedging
GARCH model
Markov regime switching
Commodity futures
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Summary:This paper investigates the hedging effectiveness of commodity futures when the correlations of spot and futures returns are subject to multi-state regime shifts. An independent switching dynamic conditional correlation GARCH ( IS-DCC) which is free from the problems of path-dependency and recombining is applied to model multi-regime switching correlations. The results of hedging exercises indicate that state-dependent IS-DCC outperforms state-independent DCC GARCH and three-state IS-DCC exhibits superior hedging effectiveness, illustrating importance of modeling higher-state switching correlations for dynamic futures hedging.
Bibliography:SourceType-Scholarly Journals-1
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ISSN:0378-4266
1872-6372
DOI:10.1016/j.jbankfin.2010.05.009