Copper futures hedging based on Markov switching approach
by Jiaxuan Chen
International Journal of Industrial and Systems Engineering (IJISE), Vol. 44, No. 3, 2023

Abstract: This paper selects the daily closing spot and futures prices of copper in China's market from May 5, 1995 to February 28, 2020, and then proposes a two-regime bivariate Markov regime-switching model, DCC-GARCH, CCC-GARCH and the OLS model to estimate their time-varying minimum variance hedging ratio and hedging performance for comparison both in- and out-of-sample. The empirical results show that, whether in- or out-of-sample, the two-regime bivariate Markov regime-switching model can provide more detail depiction of dynamic correlation between spot and futures, and outperforms the others for hedging performance. Next is the DCC-GARCH model. CCC-GARCH model and the OLS model have similar performance. Besides, the rolling-window method can make the changes more obvious in the correlation of financial assets, which helps to estimate the time-varying optimal hedging ratio in the fast-changing market.

Online publication date: Fri, 14-Jul-2023

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