Regime switching correlation hedging |
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Authors: | Hsiang-Tai Lee |
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Affiliation: | Department of Banking and Finance, 1, University Rd., Puli, National Chi Nan University, Nantou Hsien 54561, Taiwan |
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Abstract: | This paper investigates the hedging effectiveness of commodity futures when the correlations of spot and futures returns are subject to multi-state regime shifts. An independent switching dynamic conditional correlation GARCH (IS-DCC) which is free from the problems of path-dependency and recombining is applied to model multi-regime switching correlations. The results of hedging exercises indicate that state-dependent IS-DCC outperforms state-independent DCC GARCH and three-state IS-DCC exhibits superior hedging effectiveness, illustrating importance of modeling higher-state switching correlations for dynamic futures hedging. |
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Keywords: | C32 G13 |
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