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Optimal portfolio diversification with a multi-chain regime-switching spillover GARCH model

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  • Lee, Chien-Chiang
  • Lee, Hsiang-Tai

Abstract

A multi-chain regime-switching spillover GARCH (MCRSSG) model is proposed for optimal portfolio diversification. MCRSSG specifies the within-regime time-varying correlation via a multi-chain state-dependent spillover factor and quantifies the magnitude of volatility spillovers under different regime combinations. MCRSSG is applied to investigate the diversification benefit of precious metals, crude oil, and financial securities for the Korean stock market at a sector level. The empirical results reveal that the Dow Jones Islamic market US total return index provides the best diversification benefit and MCRSSG exhibits superior effectiveness for risk-adjusted return and reward-to-semivariance ratio.

Suggested Citation

  • Lee, Chien-Chiang & Lee, Hsiang-Tai, 2023. "Optimal portfolio diversification with a multi-chain regime-switching spillover GARCH model," Global Finance Journal, Elsevier, vol. 55(C).
    • Handle: RePEc:eee:glofin:v:55:y:2023:i:c:s1044028323000030
    DOI: 10.1016/j.gfj.2023.100808
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    More about this item

    Keywords

    Multiple state variables; Regime switching; GARCH; Volatility spillover; Time-varying correlation;
    All these keywords.

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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