Optimal hedging with a regime-switching time-varying correlation GARCH model

✍ Scribed by Hsiang-Tai Lee; Jonathan Yoder

• Publisher: John Wiley and Sons
• Year: 2007
• Tongue: English
• Weight: 307 KB
• Volume: 27
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.20256

✦ Synopsis

Abstract

The authors develop a Markov regime‐switching time‐varying correlation generalized autoregressive conditional heteroscedasticity (RS‐TVC GARCH) model for estimating optimal hedge ratios. The RS‐TVC nests within it both the time‐varying correlation GARCH (TVC) and the constant correlation GARCH (CC). Point estimates based on the Nikkei 225 and the Hang Seng index futures data show that the RS‐TVC outperforms the CC and the TVC both in‐ and out‐of‐sample in terms of variance reduction. Based on H. White's (2000) reality check, the null hypothesis of no improvement of the RS‐TVC over the TVC is rejected for the Nikkei 225 index contract but is not rejected for the Hang Seng index contract. © 2007 Wiley Periodicals, Inc. Jrl Fut Mark 27:495–516, 2007