VECM-EGARCH Hybrid Model

The VECM-EGARCH hybrid model is a production-level investment strategy that integrates long-term equilibrium analysis with advanced volatility modeling.

1. VECM (Vector Error Correction Model)

VECM models the long-term equilibrium relationship between multiple assets through cointegration. While assets may diverge in the short term, cointegration ensures they eventually revert to their equilibrium state.

2. EGARCH (Exponential GARCH)

EGARCH models the volatility clustering and leverage effect (where negative shocks increase volatility more than positive shocks). This allows for more accurate risk estimation and prediction interval calculation.

Why Hybrid?

  • VECM captures the structure and relationship between assets but ignores volatility patterns.
  • EGARCH captures volatility precisely but ignores structural relationships.
  • The Hybrid approach combines both, providing a comprehensive view of both price direction and risk.

3. Information Leakage Prevention

In production, we use a Walking Forward approach. We only use data up to time t-1 to predict time t, ensuring no future information "leaks" into the model's decision-making process.

4. Dynamic Re-optimization

Markets are dynamic. When the cointegration relationship weakens (indicated by the Alpha parameter), the model automatically triggers a re-optimization process to find new optimal parameters.