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Optimal hedging in carbon emission markets using Markov regime switching models

Philip, D.; Shi, Y.

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Authors

Y. Shi



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.

Citation

Philip, D., & Shi, Y. (2016). Optimal hedging in carbon emission markets using Markov regime switching models. Journal of International Financial Markets, Institutions and Money, 43, 1-15. https://doi.org/10.1016/j.intfin.2016.03.003

Journal Article Type Article
Acceptance Date Mar 25, 2016
Online Publication Date Apr 1, 2016
Publication Date Jul 1, 2016
Deposit Date Mar 29, 2016
Publicly Available Date Apr 1, 2017
Journal Journal of International Financial Markets, Institutions and Money
Print ISSN 1042-4431
Publisher Elsevier
Peer Reviewed Peer Reviewed
Volume 43
Pages 1-15
DOI https://doi.org/10.1016/j.intfin.2016.03.003
Public URL https://durham-repository.worktribe.com/output/1408350

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