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A Markov regime‐switching Cholesky GARCH model for directly estimating the dynamic of optimal hedge ratio

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  • Hsiang‐Tai Lee

Abstract

A Markov regime‐switching Cholesky GARCH (RSCHAR) model is proposed for directly estimating the optimal hedge ratio. The basic structure of RSCHAR is to transform the original series into a vector of orthogonal factors using Cholesky decomposition and fit these factors with regime‐switching dynamics. RSCHAR specifies directly the regime‐switching dynamic of conditional hedge ratio instead of recovering it indirectly from the estimated conditional covariance matrix. An estimation procedure is proposed for estimating RSCHAR. The empirical results reveal that RSCHAR exhibits superior effectiveness for multiple futures hedging based on the criterion of variance reduction, lower partial moment, and model confidence set.

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  • Hsiang‐Tai Lee, 2022. "A Markov regime‐switching Cholesky GARCH model for directly estimating the dynamic of optimal hedge ratio," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(3), pages 389-412, March.
    • Handle: RePEc:wly:jfutmk:v:42:y:2022:i:3:p:389-412
    DOI: 10.1002/fut.22286
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    Cited by:

    1. Lee, Hsiang-Tai, 2022. "Regime-switching angular correlation diversification," Finance Research Letters, Elsevier, vol. 50(C).
    2. Zhu, Pengfei & Lu, Tuantuan & Chen, Shenglan, 2022. "How do crude oil futures hedge crude oil spot risk after the COVID-19 outbreak? A wavelet denoising-GARCHSK-SJC Copula hedge ratio estimation method," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 607(C).
    3. 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).
    4. Hsiang‐Tai Lee, 2024. "Riemannian‐geometric regime‐switching covariance hedging," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 44(6), pages 1003-1054, June.
    5. 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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