Natural gas price, market fundamentals and hedging effectiveness

Song-Zan Chiou-Wei, Sheng-Hung Chen and Zhen Zhu

The Quarterly Review of Economics and Finance, 2020, vol. 78, issue C, 321-337

Abstract: How to effectively manage risk is an important issue that the financial and commodity industries face. One of the issues is the estimation of the financial and consumption asset price volatility and estimation of the optimal hedge ratio. Our study examines whether it is important to incorporate fundamental variables in estimating price returns and volatilities by studying the U.S. natural gas market. In doing so, we explain the spot and futures returns and volatilities based on market fundamental variables such as weather, gas underground storage, oil price and macroeconomic news. We find significant impacts of most of these variables on gas price. In addition, we calculate the optimal hedge ratio based on the price and volatility estimations. Our empirical evidence suggests that, as expected, the optimal hedge ratio was not constant but fluctuated significantly during the sample period. Incorporating time-varying hedge ratio has improved hedging effectiveness by a large percentage. In addition, incorporating market fundamental variables further improves the hedging effectiveness significantly. Our empirical results support the proposition that it is important to incorporate fundamental market variables in analyzing commodity price movement and improving hedging effectiveness.

Keywords: Natural gas Market; Hedge ratio; Volatility; Weather; Macroeconomic News; DCC-MGARCH; VECM (search for similar items in EconPapers)
JEL-codes: G13 Q40 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:quaeco:v:78:y:2020:i:c:p:321-337

DOI: 10.1016/j.qref.2020.05.001

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