The (De)merits of Minimum-Variance Hedging: Application to the Crack Spread

Carol Alexander, Marcel Prokopczuk () and Anannit Sumawong
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Anannit Sumawong: ICMA Centre, Henley Business School, University of Reading

ICMA Centre Discussion Papers in Finance from Henley Business School, University of Reading

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, great 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 are statistically and economically indistinguishable from the one-for-one 'naïve' hedge. However, margin and transaction costs produced by GARCH-based models are excessive. Therefore we encourage hedgers to use a na ¨ive hedging strategy on the crack spread bundles now offered by the exchange as it 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 G32 (search for similar items in EconPapers)
Date: 2012-01
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Citations: View citations in EconPapers (1)

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Journal Article: The (de)merits of minimum-variance hedging: Application to the crack spread (2013)
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