Hedging systematic risk in the commodity market with a regime-switching multivariate rotated generalized autoregressive conditional heteroskedasticity model

In this paper, a regime-switching multivariate rotated BEKK generalized autoregressive conditional heteroskedasticity (GARCH; RS-MRBEKK) model for optimal futures hedging is proposed. The basic structure of the RS-MRBEKK model is to rotate returns with spectral decomposition and fit the rotated returns with a Markov regime-switching BEKK covariance structure that is computationally attractive for modeling higher-dimensional regime-switching GARCH dynamics. The empirical results reveal that adding additional commodity index futures to capture the commodity price comovement under regime switching improves hedging performance. The more parsimonious RS-MRBEKK is statistically no worse than the conventional nonrotated regime-switching BEKK, illustrating the usefulness of RS-MRBEKK in higher-dimensional hedging applications.