A Markov Regime Switching Time Varying Correlation GARCH Model with Asymmetric Basis Effect for Energy Futures Hedging
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Abstract
This article applies a Markov regime- switching time-varying correlation GARCH model with asymmetric basis effect (RS-VC-Basis-GARCH) for energy futures hedging. This model nests within it the Markov regime switching time-varying correlation GARCH (RS-VC-GARCH) proposed by Lee and Yoder and the Time-varying correlation GARCH model with asymmetric basis effect (VC-Basis-GARCH) proposed by Lien and Yang (2006). We investigate simultaneously the effects of Markov regime-switching and the asymmetric basis on futures hedging. Four energy futures, crude oil, heating oil, gasoline and propane data are used for empirical study. We find that taking account of the effect of regime-switching improves the hedging performance out-of-sample for all data and taking account of both the effects of regime-switching and asymmetric basis further improves the hedging performance for heating oil and propane.
