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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. Copyright 2006 Organization of the Petroleum Exporting Countries.

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Bibliographic Info

Article provided by Organization of the Petroleum Exporting Countries in its journal OPEC Review.

Volume (Year): 30 (2006)
Issue (Month): 2 (06)
Pages: 55-70

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Handle: RePEc:bla:opecrv:v:30:y:2006:i:2:p:55-70

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Cited by:
  1. Tansuchat, R. & Chang, C-L. & McAleer, M.J., 2010. "Crude Oil Hedging Strategies Using Dynamic Multivariate GARCH," Econometric Institute Research Papers EI 2010-10, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  2. 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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