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A Multivariate Markov Regime‐Switching High‐Frequency‐Based Volatility Model for Optimal Futures Hedging

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  • Yu‐Sheng Lai
  • Her‐Jiun Sheu
  • Hsiang‐Tai Lee

Abstract

This study proposes a multivariate Markov regime‐switching high‐frequency‐based volatility (MRS‐HEAVY) model for modeling the covariance structure of spot and futures returns, and estimating the associated hedge ratios. S&P 500 equity index data are used in estimations, and the results reveal that the MRS‐HEAVY model has a shorter response time than that of the Markov regime‐switching GARCH model; this difference is more pronounced in the high‐volatility regime than in the low‐volatility regime. Out‐of‐sample hedging exercises illustrate that the MRS‐HEAVY exhibits superior hedging performance in terms of both variance reductions and utility gains; it is robust even when transaction costs are considered. © 2017 Wiley Periodicals, Inc. Jrl Fut Mark 37:1124–1140, 2017

Suggested Citation

  • Yu‐Sheng Lai & Her‐Jiun Sheu & Hsiang‐Tai Lee, 2017. "A Multivariate Markov Regime‐Switching High‐Frequency‐Based Volatility Model for Optimal Futures Hedging," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 37(11), pages 1124-1140, November.
    • Handle: RePEc:wly:jfutmk:v:37:y:2017:i:11:p:1124-1140
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    Cited by:

    1. Zhang Yue & Arash Farnoosh, 2018. "Analysing the Dynamic Impact of Electricity Futures on Revenue and Risks of Renewable Energy in China," Working Papers hal-03188814, HAL.
    2. Stavros Degiannakis & Christos Floros & Enrique Salvador & Dimitrios Vougas, 2022. "On the stationarity of futures hedge ratios," Operational Research, Springer, vol. 22(3), pages 2281-2303, July.
    3. Billio, Monica & Casarin, Roberto & Osuntuyi, Anthony, 2018. "Markov switching GARCH models for Bayesian hedging on energy futures markets," Energy Economics, Elsevier, vol. 70(C), pages 545-562.
    4. Dohyun Chun & Donggyu Kim, 2022. "State Heterogeneity Analysis of Financial Volatility using high‐frequency Financial Data," Journal of Time Series Analysis, Wiley Blackwell, vol. 43(1), pages 105-124, January.
    5. Zhang, Yue & Farnoosh, Arash, 2019. "Analyzing the dynamic impact of electricity futures on revenue and risk of renewable energy in China," Energy Policy, Elsevier, vol. 132(C), pages 678-690.
    6. Lee, Hsiang-Tai & Lee, Chien-Chiang, 2022. "A regime-switching real-time copula GARCH model for optimal futures hedging," International Review of Financial Analysis, Elsevier, vol. 84(C).
    7. 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).

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