A Markov-Switching VSTOXX Trading Algorithm for Enhancing EUR Stock Portfolio Performance

Oscar V. De la Torre-Torres, Evaristo Galeana-Figueroa and José Álvarez-García
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Oscar V. De la Torre-Torres: Facultad de Contaduría y Ciencias Administrativas, Universidad Michoacana de San Nicolás de Hidalgo (UMSNH), 58000 Morelia, Mexico
Evaristo Galeana-Figueroa: Facultad de Contaduría y Ciencias Administrativas, Universidad Michoacana de San Nicolás de Hidalgo (UMSNH), 58000 Morelia, Mexico
José Álvarez-García: Financial Economy and Accounting Department, Faculty of Business, Finance and Tourism, University of Extremadura, 10071 Cáceres, Spain

Mathematics, 2021, vol. 9, issue 9, 1-28

Abstract: In the present paper, we test the benefit of using Markov-Switching models and volatility futures diversification in a Euro-based stock portfolio. With weekly data of the Eurostoxx 50 (ESTOXX50) stock index, we forecasted the smoothed regime-specific probabilities at T + 1 and used them as the weighting method of a diversified portfolio in ESTOXX50 and ESTOSS50 volatility index (VSTOXX) futures. With the estimated smoothed probabilities from 9 July 2009 to 29 September 2020, we simulated the performance of three theoretical investors who paid different trading costs and invested in ESTOXX50 during calm periods (low volatility regime) or VSTOXX futures and the three-month German treasury bills in distressed or highly distressed periods (high and extreme volatility regimes). Our results suggest that diversification benefits hold in the short-term, but if a given investor manages a two-asset portfolio with ESTOXX50 and our simulated portfolios, the stock portfolio’s performance is enhanced significantly, in the long term, with the presence of trading costs. These results are of use to practitioners for algorithmic and active trading applications in ESTOXX50 ETFs and VSTOXX futures.

Keywords: Markov-Switching GARCH; volatility futures; VSTOXX; volatility hedging; active portfolio management; algorithmic trading; VSTOXX futures trading; active stock trading (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 (2)

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