Volatility Transmission across Currency, Commodity and Equity Markets under Multi-Chain Regime Switching: Implications for Hedging and Portfolio Allocation

This paper uses the multi-chain Markov Switching model to examine the nature of the volatility transmission across currency, commodity and stock markets, and provide implications for hedging and asset allocation. Results generally indicate the dominant presence of interdependency, as opposed to spillover and comovement relationships, highlighting the mutual reciprocity of individual market shocks across assets. Furthermore, there is evidence that optimal hedge ratios and portfolio weights are regime dependent. For instance, we find that it is more expensive to hedge when the market is in turmoil than when it is tranquil, and portfolio weights are larger for assets that are in the low volatility state.