Crude Oil Hedging Strategies Using Dynamic Multivariate GARCH
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.
|Keywords||conditional correlations, crude oil prices, hedging strategies, multivariate GARCH, optimal hedge ratio, optimal portfolio weights|
|JEL||Time-Series Models; Dynamic Quantile Regressions (jel C22), Time-Series Models; Dynamic Quantile Regressions (jel C32), Portfolio Choice; Investment Decisions (jel G11), Financial Forecasting (jel G17), Financing Policy; Capital and Ownership Structure (jel G32)|
|Publisher||Erasmus School of Economics (ESE)|
Tansuchat, R, Chang, C-L, & McAleer, M.J. (2010). Crude Oil Hedging Strategies Using Dynamic Multivariate GARCH (No. EI 2010-10). Report / Econometric Institute, Erasmus University Rotterdam (pp. 1–33). Erasmus School of Economics (ESE). Retrieved from http://hdl.handle.net/1765/18036