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Optimal hedging in carbon emission markets using Markov regime switching models

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journal contribution
posted on 06.04.2016, 11:25 by Dennis Philip, Yukun Shi
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.

History

Citation

Journal of International Financial Markets, Institutions & Money, 2016, 43, pp. 1-15

Author affiliation

/Organisation/COLLEGE OF SOCIAL SCIENCES, ARTS AND HUMANITIES/School of Management

Version

AM (Accepted Manuscript)

Published in

Journal of International Financial Markets

Publisher

Elsevier

issn

1042-4431

Acceptance date

25/03/2016

Copyright date

2016

Available date

01/04/2019

Publisher version

http://www.sciencedirect.com/science/article/pii/S1042443116300142

Notes

The file associated with this record is under a 36-month embargo from publication in accordance with the publisher's self-archiving policy. The full text may be available through the publisher links provided above.

Language

en