Hedging Benefits of Gold Futures- A Regime Switching Model Approach

Abstract

Using a regime switching model, this study analyzes the nature of gold hedging benefus from the perspective of an individual investor who may choose to invest in a portfolio of- a) Index Futures, b) T-note Futures, c) Oil Futures and d) Gold Futures. Empirical.findings support the argument that two distinctive identifiable regimes of gold futures returns exist: 1) a negative return with higher volatility regime and 2) a positive return with lower volatility regime. Between the two regimes, hedging benefits of gold are more pronounced during the higher volatility regimes when compared with the index-fuJures that represent the overall market. When other Tbond future, AAA Bond and CCC Bond index returns are considered as benchmarks, we find similar evidence consistent with this argument. We also compare the hedge benefits for the gold futures during the 2008 financial crisis; results suggest that hedge benefits for gold futures are more pronounced in both the regimes during the financial crisis when compared with futures returns in other non-financial crisis sample.