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

Carol Alexander, Marcel Prokopczuk () and Anannit Sumawong

Energy Economics, 2013, vol. 36, issue C, 698-707

Abstract: 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.

Keywords: Hedging; Crack spread; GARCH; Minimum-variance hedge (search for similar items in EconPapers)
JEL-codes: C52 G10 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (31)

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Working Paper: The (De)merits of Minimum-Variance Hedging: Application to the Crack Spread (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:36:y:2013:i:c:p:698-707

DOI: 10.1016/j.eneco.2012.11.016

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