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Copper futures hedging based on Markov switching approach

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  • Jiaxuan Chen

Abstract

This paper selects the daily closing spot and futures prices of copper in China's market from May 5, 1995 to February 28, 2020, and then proposes a two-regime bivariate Markov regime-switching model, DCC-GARCH, CCC-GARCH and the OLS model to estimate their time-varying minimum variance hedging ratio and hedging performance for comparison both in- and out-of-sample. The empirical results show that, whether in- or out-of-sample, the two-regime bivariate Markov regime-switching model can provide more detail depiction of dynamic correlation between spot and futures, and outperforms the others for hedging performance. Next is the DCC-GARCH model. CCC-GARCH model and the OLS model have similar performance. Besides, the rolling-window method can make the changes more obvious in the correlation of financial assets, which helps to estimate the time-varying optimal hedging ratio in the fast-changing market.

Suggested Citation

  • Jiaxuan Chen, 2023. "Copper futures hedging based on Markov switching approach," International Journal of Industrial and Systems Engineering, Inderscience Enterprises Ltd, vol. 44(3), pages 316-335.
    • Handle: RePEc:ids:ijisen:v:44:y:2023:i:3:p:316-335
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