A Test of Using Markov-Switching GARCH Models in Oil and Natural Gas Trading

Oscar V. De la Torre-Torres, Evaristo Galeana-Figueroa and José Álvarez-García
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Oscar V. De la Torre-Torres: Faculty of Accounting and Management, Saint Nicholas and Hidalgo Michoacán State University (UMSNH), 58030 Morelia, Mexico
Evaristo Galeana-Figueroa: Faculty of Accounting and Management, Saint Nicholas and Hidalgo Michoacán State University (UMSNH), 58030 Morelia, Mexico
José Álvarez-García: Financial Economy and Accounting Department, Faculty of Business, Finance and Tourism, University of Extremadura, 10071 Cáceres, Spain
Authors registered in the RePEc Author Service: Oscar Valdemar De la Torre Torres ()

Energies, 2019, vol. 13, issue 1, 1-24

Abstract: In this paper, we test the use of Markov-switching (MS) GARCH (MSGARCH) models for trading either oil or natural gas futures. Using weekly data from 7 January 1994 to 31 May 2019, we tested the next trading rule: to invest in the simulated commodity if the investor expects to be in the low-volatility regime at t + 1 or to otherwise hold the risk-free asset. Assumptions for our simulations included the following: (1) we assumed that the investors trade in a homogeneous (Gaussian or t-Student) two regime context and (2) the investor used a time-fixed, ARCH, or GARCH variance in each regime. Our results suggest that the use of the MS Gaussian model, with time-fixed variance, leads to the best performance in the oil market. For the case of natural gas, we found no benefit of using our trading rule against a buy-and-hold strategy in the three-month U.S. Treasury bills.

Keywords: Markov-switching; Markov-switching GARCH; energy futures; commodities; portfolio management; active investment; diversification; institutional investors; energy price hedging (search for similar items in EconPapers)
JEL-codes: Q Q0 Q4 Q40 Q41 Q42 Q43 Q47 Q48 Q49 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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