University of Sussex
Browse

File(s) under permanent embargo

The (de)merits of minimum-variance hedging: application to the crack spread

journal contribution
posted on 2023-06-08, 15:06 authored by Carol AlexanderCarol Alexander, Marcel Prokopczuk, Anannit Sumawong
We study the empirical performance of the classical minimum-variance hedging strategy, comparing several econometric models for estimating hedge ratios of crude oil, gasoline and heating oil crack spreads. Given the great variability and large jumps in both spot and futures prices, considerable care is required when processing the relevant data and accounting for the costs of maintaining and re-balancing the hedge position. We find that the variance reduction produced by all models is statistically and economically indistinguishable from the one-for-one “naïve” hedge. However, minimum-variance hedging models, especially those based on GARCH, generate much greater margin and transaction costs than the naïve hedge. Therefore we encourage hedgers to use a naïve hedging strategy on the crack spread bundles now offered by the exchange; this strategy is the cheapest and easiest to implement. Our conclusion contradicts the majority of the existing literature, which favours the implementation of GARCH-based hedging strategies.

History

Publication status

  • Published

File Version

  • Published version

Journal

Energy Economics

ISSN

0140-9883

Publisher

Elsevier

Volume

36

Page range

698-707

Department affiliated with

  • Business and Management Publications

Full text available

  • No

Peer reviewed?

  • Yes

Legacy Posted Date

2013-06-02

First Compliant Deposit (FCD) Date

2013-06-02

Usage metrics

    University of Sussex (Publications)

    Categories

    No categories selected

    Exports

    RefWorks
    BibTeX
    Ref. manager
    Endnote
    DataCite
    NLM
    DC