Article ID | Journal | Published Year | Pages | File Type |
---|---|---|---|---|
7364452 | Journal of International Financial Markets, Institutions and Money | 2016 | 15 Pages |
Abstract
This paper proposes a Markov regime switching framework for modeling carbon emission (CO2) allowances that combines a regime switching behavior and disequilibrium adjustments in the mean process, along with a state-dependent dynamic volatility process. We find that all regime switching based hedging strategies significantly outperform single regime hedging strategies (both in-sample and out-of-sample), with the newly proposed framework providing the greatest variance reduction and the best hedging performance. Our results indicate that risk managers using state-dependent hedge ratios to manage portfolio risks in carbon emission markets will achieve superior hedging returns.
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Authors
Dennis Philip, Yukun Shi,