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Price volatility, hedging and variable risk premium in the crude oil market

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  • Ahmad R. Jalali‐Naini
  • Maryam Kazemi Manesh

Abstract

The crude oil price exhibits a high degree of volatility which varies significantly over time. Such characteristics imply that the oil market is a promising area for testing volatility models. Testing and predicting volatility using ARCH and GARCH models have grown in the literature. A useful application of the volatility models is in the formulation of hedging strategies. In this paper we compare the optimal hedge ratio for the crude oil using the classical minimum risk approach and use ARCH to incorporate the effect of heteroskedasticity in the residuals on the hedge ratio. In addition, we test for the existence of a variable risk premium in the crude oil market. We find that, assuming rational expectations, there is a non‐zero risk premium. We test for the variability of the risk premia and find evidence in its support when we employed a multivariate GARCH model.

Suggested Citation

  • Ahmad R. Jalali‐Naini & Maryam Kazemi Manesh, 2006. "Price volatility, hedging and variable risk premium in the crude oil market," OPEC Energy Review, Organization of the Petroleum Exporting Countries, vol. 30(2), pages 55-70, June.
    • Handle: RePEc:bla:opecrv:v:30:y:2006:i:2:p:55-70
    DOI: 10.1111/j.1468-0076.2006.00161.x
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    References listed on IDEAS

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    Cited by:

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    2. Chang, Chia-Lin & McAleer, Michael & Tansuchat, Roengchai, 2011. "Crude oil hedging strategies using dynamic multivariate GARCH," Energy Economics, Elsevier, vol. 33(5), pages 912-923, September.
    3. Quintino, António & Catalão-Lopes, Margarida & Lourenço, João Carlos, 2019. "Can switching from gasoline to aromatics mitigate the price risk of refineries?," Energy Policy, Elsevier, vol. 134(C).
    4. Marc H. Vatter, 2019. "OPEC’s Risk Premia and Volatility in Oil Prices," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 25(2), pages 165-175, May.
    5. Chun, Dohyun & Cho, Hoon & Kim, Jihun, 2019. "Crude oil price shocks and hedging performance: A comparison of volatility models," Energy Economics, Elsevier, vol. 81(C), pages 1132-1147.
    6. Wang, Shuang & Wallace, Stein W. & Lu, Jing & Gu, Yewen, 2020. "Handling financial risks in crude oil imports: Taking into account crude oil prices as well as country and transportation risks," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 133(C).
    7. George E. Halkos & Apostolos S. Tsirivis, 2019. "Energy Commodities: A Review of Optimal Hedging Strategies," Energies, MDPI, vol. 12(20), pages 1-19, October.
    8. Chang, Chiao-Yi & Lai, Jing-Yi & Chuang, I-Yuan, 2010. "Futures hedging effectiveness under the segmentation of bear/bull energy markets," Energy Economics, Elsevier, vol. 32(2), pages 442-449, March.

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