Hedging downside risk of oil refineries: A vine copula approach

Kunlapath Sukcharoen and David Leatham ()

Energy Economics, 2017, vol. 66, issue C, 493-507

Abstract: The financial health of an oil refinery greatly depends on its refining margin or the difference between the prices of its refined products (typically, gasoline and heating oil) and the cost of crude oil. The refinery may hedge against the downside risk of unfavorable price movements using crude oil, gasoline, and heating oil futures. This paper examines the use of a vine copula approach to estimate multiproduct hedge ratios that minimize the downside risk of the refinery. The advantage of the vine copula approach is that it allows us to capture important characteristics of petroleum price changes, including skewness and fat-tailedness in the marginal distributions of individual price change series as well as heterogeneous (tail) dependence patterns between different pairs of price changes. The out-of-sample hedging effectiveness of two popular classes of vine copula models – canonical (C-) and drawable (D-) vine copula models – are evaluated and compared with that of the widely used nonparametric method and three standard multivariate copula models. The empirical results reveal that the D-vine copula model is a good and safe choice in managing the downside risk of the refinery.

Keywords: Downside risk; Energy hedging; Futures hedging; Multiproduct hedging; Vine copula (search for similar items in EconPapers)
JEL-codes: C53 C58 G11 G17 G32 Q40 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (25)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0140988317302499
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:66:y:2017:i:c:p:493-507

DOI: 10.1016/j.eneco.2017.07.012

Access Statistics for this article

Energy Economics is currently edited by R. S. J. Tol, Beng Ang, Lance Bachmeier, Perry Sadorsky, Ugur Soytas and J. P. Weyant

More articles in Energy Economics from Elsevier
Bibliographic data for series maintained by Catherine Liu ().