Optimal hedging of quantitative risk based on Markov regime change in coin futures contract

Subject Areas : Risk Management

Sayyed Mohammad Reza Davoodi ¹ , Marzieh Karami Chamgordani ² , Sayyed AmirReza Hashemi ³

1 - Department of Management, Dehaghan Branch, Islamic Azad University, Dehaghan, Iran.
2 - Department of Finance, Yazd University, Yazd, Iran.
3 - Department of Management, Dehaghan Branch, Islamic Azad University, Dehaghan, Iran.

Received: 2023-01-01 Accepted : 2023-04-04 Published : 2023-06-22

Keywords: Quantile Regression, hedging ratio, future contract, switching Markov,

Abstract :

Objective: One of the key roles of futures markets is to provide risk hedging tools. The optimal strategy for risk hedging is determined by estimating the risk hedging ratio. Calculating the risk hedging ratio and the effectiveness of hedging explicitly depend on the relationship between futures prices and spot prices. Therefore, the aim of this study is to estimate the optimal risk hedging ratio in various timeframes under low and high volatility conditions using a Markov regime-switching multivariate regression model.Methodology: The slope obtained from the Markov regime-switching multivariate regression, representing the optimal risk hedging ratio, is chosen, which is dependent on the choice of timeframes and two cases for the multivariate regression model are adopted according to the level of volatility considered.Findings: The research results on 5 futures contracts in the period from 2014 to 2018 indicate that in three markets, normal (composite), low volatility, and high volatility, risk hedging has been able to reduce risk by at least 20%. In the high volatility market, the optimal risk hedging ratio has reduced volatility by at least 23% in all timeframes (with the mean square error criterion), and the 0/95 timeframe performs the best in terms of the highest reduction in volatility and the lowest risk hedging ratio. In the low volatility market, the optimal risk hedging ratio has reduced volatility by at least 58% in all timeframes, and the 0/05 timeframe performs the best in terms of the highest reduction in volatility and the lowest risk hedging ratio. In the composite market, the optimal risk hedging ratio has also reduced volatility by 21%.Originality / Value: The results of this study not only contribute to the literature on risk hedging but also assist all stakeholders and users in evaluating the level of attention to the risk hedging topic.

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