Stock index hedge using trend and volatility regime switch model considering hedging cost
This paper studies the risk hedging between stock index and underlying futures. The hedging ratios are optimized using the mean-variance utility function as considering the hedging cost. The trend of returns and variance are estimated by the model of regime switch on both vector autoregression (VAR) and GARCH(1,1) compared to three restricted models: VAR switch only, GARCH(1,1) switch only, and no switch. The hedge portfolio is constructed by Morgan Stanley Taiwan Index (MSTI) and Singapore Traded MSTI futures. The hedge horizon is set as a week to reduce the hedging cost and the weekly in-sample data cover from 08/09/2001 to 05/31/2007. The rolling window technique is used to evaluate the hedge performances of out-of-sample period spanning subprime, Greek debt, and post-risk durations. The subprime period indeed is evidenced very vital to achieve the hedge performance. All models perform surprisingly far above average during subprime period. The hedge ratios indeed are the tradeoff between maximum expected return and minimum variance. It is demonstrated challenging for all models to increase returns and reduce risk together. The hedge context is further classified into four hedge states: uu, ud, du, and dd (u and d denote respectively usual and down) using the state probabilities of series. The regime switch models are found to have much greater wealth increase when in dd state. It is decisive to hedge risk in dd state when volatility is extensively higher as observed recurrently in subprime period. Remarkably, the trend switch is found having larger wealth increase while the volatility switch is not found prominent between models. While the no switch model has larger utility increase in uu state as most observed in Greek debt or post risk period, its performance is far below average like other models.
|Date of creation:||09 Jan 2013|
|Date of revision:|
|Contact details of provider:|| Postal: Ludwigstraße 33, D-80539 Munich, Germany|
Web page: https://mpra.ub.uni-muenchen.de
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Franc Klaassen, 2002. "Improving GARCH volatility forecasts with regime-switching GARCH," Empirical Economics, Springer, vol. 27(2), pages 363-394.
- Hamilton, James D, 1991. "A Quasi-Bayesian Approach to Estimating Parameters for Mixtures of Normal Distributions," Journal of Business & Economic Statistics, American Statistical Association, vol. 9(1), pages 27-39, January.
- Jin, Hyun J. & Koo, Won W., 2006. "Offshore hedging strategy of Japan-based wheat traders under multiple sources of risk and hedging costs," Journal of International Money and Finance, Elsevier, vol. 25(2), pages 220-236, March.
- Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
- Marcucci Juri, 2005. "Forecasting Stock Market Volatility with Regime-Switching GARCH Models," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 9(4), pages 1-55, December.
- Lence, Sergio H., 1995.
"The Economic Value of Minimum-Variance Hedges,"
Staff General Research Papers Archive
5053, Iowa State University, Department of Economics.
- Pelletier, Denis, 2006.
"Regime switching for dynamic correlations,"
Journal of Econometrics,
Elsevier, vol. 131(1-2), pages 445-473.
- Denis Pelletier, 2004. "Regime Switching for Dynamic Correlations," Econometric Society 2004 North American Summer Meetings 230, Econometric Society.
- Anderson, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Labys, Paul, 2002.
"Modeling and Forecasting Realized Volatility,"
02-12, Duke University, Department of Economics.
- Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Paul Labys, 2001. "Modeling and Forecasting Realized Volatility," NBER Working Papers 8160, National Bureau of Economic Research, Inc.
- Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Paul Labys, 2001. "Modeling and Forecasting Realized Volatility," Center for Financial Institutions Working Papers 01-01, Wharton School Center for Financial Institutions, University of Pennsylvania.
- Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
- Andrew Ang & Geert Bekaert, 2002. "International Asset Allocation With Regime Shifts," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1137-1187.
- Kee-Hong Bae & G. Andrew Karolyi & Rene M. Stulz, 2000.
"A New Approach to Measuring Financial Contagion,"
NBER Working Papers
7913, National Bureau of Economic Research, Inc.
- Ng, Lilian, 1991. " Tests of the CAPM with Time-Varying Covariances: A Multivariate GARCH Approach," Journal of Finance, American Finance Association, vol. 46(4), pages 1507-21, September.
- Babula, Ronald A. & Ruppel, Fred J. & Bessler, David A., 1995.
"U.S. corn exports: the role of the exchange rate,"
Agricultural Economics of Agricultural Economists,
International Association of Agricultural Economists, vol. 13(2), November.
- Moschini, GianCarlo & Myers, Robert J., 2002.
"Testing for Constant Hedge Ratios in Commodity Markets: A Multivariate Garch Approach,"
Staff General Research Papers Archive
1945, Iowa State University, Department of Economics.
- Moschini, GianCarlo & Myers, Robert J., 2002. "Testing for constant hedge ratios in commodity markets: a multivariate GARCH approach," Journal of Empirical Finance, Elsevier, vol. 9(5), pages 589-603, December.
- GianCarlo Moschini & Robert J. Myers, 2001. "Testing for Constant Hedge Ratios in Commodity Markets: A Multivariate GARCH Approach," Center for Agricultural and Rural Development (CARD) Publications 01-wp268, Center for Agricultural and Rural Development (CARD) at Iowa State University.
- Kroner, Kenneth F. & Sultan, Jahangir, 1993. "Time-Varying Distributions and Dynamic Hedging with Foreign Currency Futures," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(04), pages 535-551, December.
- Liu, Kang E. & Geaun, Jerome & Lei, Li-Fen, 2001. "Optimal hedging decisions for Taiwanese corn traders on the way to liberalisation," Agricultural Economics, Blackwell, vol. 25(2-3), pages 303-309, September.
- Michael S. Haigh & Matthew T. Holt, 2000. "Hedging Multiple Price Uncertainty in International Grain Trade," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 82(4), pages 881-896.
- Yun, Won-Cheol & Jae Kim, Hyun, 2010. "Hedging strategy for crude oil trading and the factors influencing hedging effectiveness," Energy Policy, Elsevier, vol. 38(5), pages 2404-2408, May.
- Gagnon, Louis & Lypny, Gregory J. & McCurdy, Thomas H., 1998. "Hedging foreign currency portfolios," Journal of Empirical Finance, Elsevier, vol. 5(3), pages 197-220, September.
- Honda, Toshiki, 2003. "Optimal portfolio choice for unobservable and regime-switching mean returns," Journal of Economic Dynamics and Control, Elsevier, vol. 28(1), pages 45-78, October.
- Bjorn Hansson & Peter Hordahl, 1998. "Testing the conditional CAPM using multivariate GARCH-M," Applied Financial Economics, Taylor & Francis Journals, vol. 8(4), pages 377-388.
- Baillie, Richard T & Myers, Robert J, 1991. "Bivariate GARCH Estimation of the Optimal Commodity Futures Hedge," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 6(2), pages 109-24, April-Jun.
- Ederington, Louis H, 1979. "The Hedging Performance of the New Futures Markets," Journal of Finance, American Finance Association, vol. 34(1), pages 157-70, March.
- Lien, Donald & Yang, Li, 2008. "Asymmetric effect of basis on dynamic futures hedging: Empirical evidence from commodity markets," Journal of Banking & Finance, Elsevier, vol. 32(2), pages 187-198, February.
- Hamilton, James D. & Susmel, Raul, 1994.
"Autoregressive conditional heteroskedasticity and changes in regime,"
Journal of Econometrics,
Elsevier, vol. 64(1-2), pages 307-333.
- Tom Doan, . "RATS programs to estimate Hamilton-Susmel Markov Switching ARCH model," Statistical Software Components RTZ00083, Boston College Department of Economics.
- Markus Haas, 2004. "A New Approach to Markov-Switching GARCH Models," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 2(4), pages 493-530.
- Haigh, Michael S. & Holt, Matthew T., 2002. "Hedging Foreign Currency, Freight And Commodity Futures Portfolios: A Note," Working Papers 28573, University of Maryland, Department of Agricultural and Resource Economics.
- Heifner, Richard G., 1972. "Optimal Hedging Levels and Hedging Effectiveness in Cattle Feeding," Agricultural Economics Research, United States Department of Agriculture, Economic Research Service, issue 2.
- Alizadeh, Amir H. & Nomikos, Nikos K. & Pouliasis, Panos K., 2008. "A Markov regime switching approach for hedging energy commodities," Journal of Banking & Finance, Elsevier, vol. 32(9), pages 1970-1983, September.
- Tse, Y K & Tsui, Albert K C, 2002. "A Multivariate Generalized Autoregressive Conditional Heteroscedasticity Model with Time-Varying Correlations," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(3), pages 351-62, July.
- Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-31, February.
When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:49190. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Joachim Winter)
If references are entirely missing, you can add them using this form.