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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 SumawongWe 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.
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Publication status
- Published
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- Published version
Journal
Energy EconomicsISSN
0140-9883Publisher
ElsevierExternal DOI
Volume
36Page range
698-707Department affiliated with
- Business and Management Publications
Full text available
- No
Peer reviewed?
- Yes
Legacy Posted Date
2013-06-02First Compliant Deposit (FCD) Date
2013-06-02Usage metrics
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