Crack spread hedging: accounting for time-varying volatility spillovers in the energy futures markets

Michael S. Haigh and Matthew Holt
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Michael S. Haigh: University of Maryland, USA, Postal: University of Maryland, USA

Journal of Applied Econometrics, 2002, vol. 17, issue 3, 269-289

Abstract: Crude oil, heating oil, and unleaded gasoline futures contracts are simultaneously analysed for their effectiveness in reducing price volatility for an energy trader. A conceptual model is developed for a trader hedging the 'crack spread'. Various hedge ratio estimation techniques are compared to a Multivariate GARCH model that directly incorporates the time to maturity effect often found in futures markets. Modelling of the time-variation in hedge ratios via the Multivariate GARCH methodology, and thus taking into account volatility spillovers between markets is shown to result in significant reductions in uncertainty even while accounting for trading costs. Copyright © 2002 John Wiley & Sons, Ltd.

Date: 2002
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