Markov Regime-Switching Volatility in Natural Gas Futures (NGH4)

Natural gas futures have been volatile this past January and February.  Over the next month I plan to look into the nature and determinants of the volatility (cold weather and relatively low storage volumes likely accounting for the lion's share).  AS a first step, I have estimated a Markov Regime-Switching AR model on March NYMEX Natural Gas (NGH4) log returns.  The AR results are:

 r_{ng,t} = \begin{cases} 0.0014 + 0.1311r_{ng,t-1}+ e_{S1,t}, \:\:\:\:\:\:\:\: e_{S1} \sim N(0,0.0323) \\ 0.0056+0.3405r_{ng,t-1}+e_{S2,t}, \:\:\:\:\:\:\: e_{S2} \sim N(0,0.0050) \end{cases}

with the transition matrix:

 P=\left[ \begin{array} 0.78 \;\;&\;\; 0.51 \\ { } & { } \\ 0.22 \;\;&\;\; 0.49 \end{array}\right]

The results indicate a high volatility and low volatility state with a 51% and 7.9% annualized volatility respectively. Weighting these unconditional state volatilities by the filtered state probability (chart below) gives an estimate of the time-varying volatility in NGH4.


The most recent estimate is a 38% annualized volatility. A chart of NGH4 is below for the same time period.



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