Optimal quantile hedging under Markov regime switching

Donald Lien, Ziling Wang and Xiaojian Yu ()
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Donald Lien: The University of Texas at San Antonio
Ziling Wang: South China University of Technology
Xiaojian Yu: South China University of Technology

Empirical Economics, 2021, vol. 60, issue 5, No 2, 2177-2201

Abstract: Abstract In this study, we introduce a new quantile hedging method by extending the conventional quantile hedging with two-state Markov regime switching models. Using daily data from 16 futures markets, we discover that the conventional quantile hedge ratio displays an inverted U shape to various extents for different futures. When looking into high- and low-volatility states, quantile hedge ratios show different results compared with conventional models. While the quantile hedge ratio in low-volatility state is relatively flat, in high-volatility state, the quantile hedge varies with the spot return distribution and displays a U-type relationship. Moreover, the U shape is more prominent for agricultural futures and less prominent for others. Also, by comparing hedging effectiveness, the quantile hedge strategy is found to be more effective than the no-hedge strategy and the hedging strategy derived from error correction models.

Keywords: Futures; Quantile hedging; Markov regime switching; Hedge ratio (search for similar items in EconPapers)
JEL-codes: C14 C22 G13 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (1)

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DOI: 10.1007/s00181-020-01831-5

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