Dynamic Dependence and Hedging of Stock Markets: Evidence From Time-Varying Copula With Asymmetric Markovian Models

Abstract

To study the asymmetric jump behaviors of the stock markets, we propose a novel autoregressive conditional jump intensity (ARJI)—generalized autoregressive conditional heteroskedasticity (GARCH) model with a Markov chain. Compared with the existing models, it considers the asymmetric effects of the positive and negative shocks on jump volatilities. It is proposed to estimate the asymmetric jump volatilities of the stock markets in mainland China and Hong Kong under different volatility regimes. Multiple time-varying copula models are used to analyze the dynamic dependences of the jump risks between the two markets. Furthermore, we construct dynamic hedging portfolios for their spot and futures markets, estimate the minimum risk hedging ratios, and measure the hedging performance. Compared with other benchmark models, the results show that the proposed one has the best fitting effect for the Chinese stock markets. The correlations between the Chinese mainland and Hong Kong markets are always positive. When constructing hedging portfolios, the proposed model is superior to other models, which means that introducing asymmetric shocks on both normal and jump volatilities into a Markovian ARJI-GARCH model can effectively improve the performance of hedging portfolios. In addition, the results of the robustness test indicates that our proposed model performs well and is robust.