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Dynamic hedging strategies: an application to the crude oil market

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Author Info

  • Delphine Lautier

    ()
    (DRM - Dauphine Recherches en Management - CNRS : UMR7088 - Université Paris IX - Paris Dauphine)

  • Alain Galli

    (CERNA - Centre d'économie industrielle - MINES ParisTech - École nationale supérieure des mines de Paris)

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    Abstract

    This article analyses long-term dynamic hedging strategies relying on term structure models of commodity prices and proposes a new way to calibrate the models which takes into account the error associated with the hedge ratios. Different strategies, with maturities up to seven years, are tested on the American crude oil futures market. The study considers three recent and efficient models respectively with one, two, and three factors. The continuity between the models makes it possible to compare their performances which are judged on the basis of the errors associated with a delta hedge. The strategies are also tested for their sensitivity to the maturities of the positions and to the frequency of the portfolio rollover. We found that our method gives the best of two seemingly incompatible worlds: the higher liquidity of short-term futures contracts for the hedge portfolios, together with markedly improved performances. Moreover, even if it is more complex, the three-factor model is by far, the best.

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    File URL: http://halshs.archives-ouvertes.fr/docs/00/64/08/02/PDF/WP_dynamic.pdf
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    Bibliographic Info

    Paper provided by HAL in its series Post-Print with number halshs-00640802.

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    Date of creation: Jul 2010
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    Publication status: Published, Review of futures markets, 2010, 19, 1, 7-41
    Handle: RePEc:hal:journl:halshs-00640802

    Note: View the original document on HAL open archive server: http://halshs.archives-ouvertes.fr/halshs-00640802
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    Related research

    Keywords: hedging strategies; commodities; term structure models; crude oil;

    References

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    1. Bryan Routledge & Duane Seppi & Chester Spatt, . "Equilibrium Forward Curves for Commodities," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1997-50, Carnegie Mellon University, Tepper School of Business.
    2. Christopher L. Culp & Merton H. Miller, 1995. "Metallgesellschaft And The Economics Of Synthetic Storage," Journal of Applied Corporate Finance, Morgan Stanley, Morgan Stanley, vol. 7(4), pages 62-76.
    3. Lautier, Delphine & Javaheri, Alireza & Galli, Alain, 2003. "Filtering in Finance," Economics Papers from University Paris Dauphine 123456789/871, Paris Dauphine University.
    4. Xuemin Yan, 2002. "Valuation of commodity derivatives in a new multi-factor model," Review of Derivatives Research, Springer, Springer, vol. 5(3), pages 251-271, October.
    5. Lautier, Delphine, 2005. "Term Structure Models of Commodity Prices: A Review," Economics Papers from University Paris Dauphine 123456789/5465, Paris Dauphine University.
    6. Hilliard, Jimmy E. & Reis, Jorge, 1998. "Valuation of Commodity Futures and Options under Stochastic Convenience Yields, Interest Rates, and Jump Diffusions in the Spot," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 33(01), pages 61-86, March.
    7. Richter, Martin & Sørensen, Carsten, 2002. "Stochastic Volatility and Seasonality in Commodity Futures and Options: The Case of Soybeans," Working Papers, Copenhagen Business School, Department of Finance 2002-4, Copenhagen Business School, Department of Finance.
    8. repec:ner:dauphi:urn:hdl:123456789/1245 is not listed on IDEAS
    9. Eduardo Schwartz & James E. Smith, 2000. "Short-Term Variations and Long-Term Dynamics in Commodity Prices," Management Science, INFORMS, INFORMS, vol. 46(7), pages 893-911, July.
    10. Neuberger, Anthony, 1999. "Hedging Long-Term Exposures with Multiple Short-Term Futures Contracts," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 12(3), pages 429-59.
    11. Gibson, Rajna & Schwartz, Eduardo S, 1990. " Stochastic Convenience Yield and the Pricing of Oil Contingent Claims," Journal of Finance, American Finance Association, American Finance Association, vol. 45(3), pages 959-76, July.
    12. Franklin R. Edwards & Michael S. Canter, 1995. "The Collapse Of Metallgesellschaft: Unhedgeable Risks, Poor Hedging Strategy, Or Just Bad Luck?," Journal of Applied Corporate Finance, Morgan Stanley, Morgan Stanley, vol. 8(1), pages 86-105.
    13. Schwartz, Eduardo S, 1997. " The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, American Finance Association, vol. 52(3), pages 923-73, July.
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