A Bivariate Markov Regime Switching GARCH Approach to Estimate Time Varying Minimum Variance Hedge Ratios

Hsiang-Tai Lee and Jonathan Keith Yoder ()
Additional contact information
Hsiang-Tai Lee: Washington State University

Econometrics from EconWPA

Abstract: This paper develops a new bivariate Markov regime switching BEKK-GARCH (RS-BEKK-GARCH) model. The model is a state-dependent bivariate BEKK- GARCH model, and an extension of Gray’s univariate generalized regime- switching (GRS) model to the bivariate case. To solve the path- dependency problem inherent in the bivariate regime switching BEKK-GARCH model, we propose a recombining method for the covariance term in the conditional variance-covariance matrix. The model is applied to estimate time-varying minimum variance hedge ratios for corn and nickel spot and futures prices. Out-of-sample point estimates of hedging portfolio variance show that compared to the state-independent BEKK-GARCH model, the RS-BEKK-GARCH model improves out-of-sample hedging effectiveness for both corn and nickel data. We perform White’s (2000) data-snooping reality check to test for predictive superiority of RS-BEKK-GARCH over the benchmark model, and find that the difference in variance reduction between BEKK-GARCH and RS-BEKK-GARCH is not statistically significant for either data set at conventional confidence levels.

Keywords: bivariate GARCH; require switching; hedging (search for similar items in EconPapers)
JEL-codes: D81 C53 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ecm, nep-ets and nep-fin
Date: 2005-06-28
Note: Type of Document - pdf; pages: 33
View list of references

Downloads: (external link)
http://129.3.20.41/eps/em/papers/0506/0506009.pdf (application/pdf)

Related works:
Journal Article: A bivariate Markov regime switching GARCH approach to estimate time varying minimum variance hedge ratios (2007)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpem:0506009

Access Statistics for this paper

More papers in Econometrics from EconWPA
Series data maintained by EconWPA ().