Enhancing Portfolio Performance and VIX Futures Trading Timing with Markov-Switching GARCH Models

Oscar V. De la Torre-Torres, Francisco Venegas-Martínez and Isabel Martínez-Torre-Enciso Mᵃ
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Oscar V. De la Torre-Torres: Facultad de Contaduría y Ciencias Administrativas, Universidad Michoacana de San Nicolás de Hidalgo (UMSNH), Morelia 58000, Mexico
Isabel Martínez-Torre-Enciso Mᵃ: Facultad de Economía y Ciencias Administrativas, Universidad Autónoma de Madrid, Madrid 28049, Spain

Mathematics, 2021, vol. 9, issue 2, 1-22

Abstract: In the present paper, we test the use of Markov-Switching (MS) models with time-fixed or Generalized Autoregressive Conditional Heteroskedasticity (GARCH) variances. This, to enhance the performance of a U.S. dollar-based portfolio that invest in the S&P 500 (SP500) stock index, the 3-month U.S. Treasury-bill (T-BILL) or the 1-month volatility index (VIX) futures. For the investment algorithm, we propose the use of two and three-regime, Gaussian and t-Student, MS and MS-GARCH models. This is done to forecast the probability of high volatility episodes in the SP500 and to determine the investment level in each asset. To test the algorithm, we simulated 8 portfolios that invested in these three assets, in a weekly basis from 23 December 2005 to 14 August 2020. Our results suggest that the use of MS and MS-GARCH models and VIX futures leads the simulated portfolio to outperform a buy and hold strategy in the SP500. Also, we found that this result holds only in high and extreme volatility periods. As a recommendation for practitioners, we found that our investment algorithm must be used only by institutional investors, given the impact of stock trading fees.

Keywords: Markov-Switching; Markov-Switching GARCH; volatility futures; VIX; portfolio management; active investment; diversification; institutional investors; volatility hedging (search for similar items in EconPapers)
JEL-codes: C (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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