Crude oil hedging strategies using dynamic multivariate GARCH

Abstract

The paper examines the performance of four multivariate volatility models, namely CCC, VARMA-GARCH, DCC and BEKK, for the crude oil spot and futures returns of two major benchmark international crude oil markets, Brent and WTI, to calculate optimal portfolio weights and optimal hedge ratios, and to suggest a crude oil hedge strategy. The empirical results show that the optimal portfolio weights of all multivariate volatility models for Brent suggest holding futures in larger proportions than spot. For WTI, however, DCC and BEKK suggest holding crude oil futures to spot, but CCC and VARMA-GARCH suggest holding crude oil spot to futures. In addition, the calculated optimal hedge ratios (OHRs) from each multivariate conditional volatility model give the time-varying hedge ratios, and recommend to short in crude oil futures with a high proportion of one dollar long in crude oil spot.Finally, the hedging effectiveness indicates that DCC (BEKK) is the best (worst) model for OHR calculation in terms of reducing the variance of the portfolio.

Do Sustainable Stocks Offer Diversification Benefits for Conventional Portfolios? An Empirical Analysis of Risk Spillovers and Dynamic Correlations

“…The dynamic conditional correlation (DCC) model used in the study follows [57][58][59] and more recently [60]. Let R t = [R s,t , R c,t ] be the (2 × 1) vector of returns where R s,t and R c,t are the return on SRI represented by a sustainability index and the return on conventional investment represented by a conventional market index, respectively.…”

“…(This model follows the minimum-variance portfolio formula of [71], where the regime-independent covariances used in the computation of portfolio weights are obtained as the probability weighted average of regime-dependent covariances with the corresponding predictive regime probabilities as the weights.) A similar procedure is applied in a similar context in [58][59][60]72]. Table 5 presents the summary statistics for the in-sample period covering 2 January 2004-19 February 2014, with 2644 observations.…”

Is small beautiful? Size effects of volatility spillovers for firm performance and exchange rates in tourism

“…The parameters of the model are obtained by maximum likelihood estimation (MLE) using a joint normal density function. When the matrix of returns shocks does not follow a joint multivariate normal distribution, the appropriate method is to use quasi-maximum likelihood estimation (QMLE) (for further details, see Chang, McAleer and Tansuchat, 2011). …”

Volatility and Risk Management in European Electricity Futures Markets

“…Oil and its derivatives, (see for example, El-Khoury, 2007,Chang, McAleer andTansuchat, 2011) and Natural Gas (Root andLien, 2003, Brinkmann andRabinovich, 2005). The general results from the literature is that hedging is generally very effective as measured by risk reductions 1 of the order of 60% -90% depending on the underlying asset being hedged.…”

“…13 See for example Chang, McAleer and Tansuchat, R., (2011)who base their study on daily data. 14 See for example Cotter and Hanly (2012).…”