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Open Access Publications from the University of California

Covariance Estimation with Markov-Switching Generalized Autoregressive Conditional Heteroskedasticity Models Applications to Portfolio Management

  • Author(s): Wisner, Tristan Gardner
  • Advisor(s): Wu, Ying Nian
  • et al.
Abstract

The objective of this paper is to implement and test the multivariate regime-switching GARCH model as a potential improvement on traditional methods for estimating the covariance matrix for multiple time series. I describe the characteristics and estimation of the primary model of interest, MS-GARCH, and some competitor models. I implement and backtest a portfolio management strategy based on risk minimization using MS-GARCH forecasts and evaluate performance relative to competitors. I find MS-GARCH to be an useful tool in portfolio construction, and to offer some significant advantages over more traditional models in terms of accuracy and interpretability when describing a process.

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