A copula-based regime-switching GARCH model for optimal futures hedging

The article develops a regime‐switching Gumbel–Clayton (RSGC) copula GARCH model for optimal futures hedging. There are three major contributions of RSGC. First, the dependence of spot and futures return series in RSGC is modeled using switching copula instead of assuming bivariate normality. Second...

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Bibliographic Details
Published in:The journal of futures markets 2009-10, Vol.29 (10), p.946-972
Main Author: Lee, Hsiang-Tai
Format: Article
Language:English
Subjects:
Agricultural commodities
Agriculture
Commodity markets
Financial engineering
Futures
Futures market
GARCH models
Hedging
Mathematical finance
Risk management
Stochastic models
Studies
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Summary:The article develops a regime‐switching Gumbel–Clayton (RSGC) copula GARCH model for optimal futures hedging. There are three major contributions of RSGC. First, the dependence of spot and futures return series in RSGC is modeled using switching copula instead of assuming bivariate normality. Second, RSGC adopts an independent switching Generalized Autoregressive Conditional Heteroscedasticity (GARCH) process to avoid the path‐dependency problem. Third, based on the assumption of independent switching, a formula is derived for calculating the minimum variance hedge ratio. Empirical investigation in agricultural commodity markets reveals that RSGC provides good out‐of‐sample hedging effectiveness, illustrating importance of modeling regime shift and asymmetric dependence for futures hedging. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:946–972, 2009
ISSN:0270-7314
1096-9934
DOI:10.1002/fut.20394