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Crude Oil Hedging Strategies Using Dynamic Multivariate GARCH

Author

Listed:
  • Roengchai Tansuchat

    (Faculty of Economics, Maejo University)

  • Chia-Lin Chang

    (Department of Applied Economics, National Chung Hsing University)

  • Michael McAleer

    (Erasmus School of Economics, Erasmus University Rotterdam and Tinbergen Institute)

Abstract

The paper examines the performance of four multivariate volatility models, namely CCC, VARMA-GARCH, DCC and BEKK, for the crude oil spot and futures returns of two major benchmark international crude oil markets, Brent and WTI, to calculate optimal portfolio weights and optimal hedge ratios, and to suggest a crude oil hedge strategy. The empirical results show that the optimal portfolio weights of all multivariate volatility models for Brent suggest holding futures in larger proportions than spot. For WTI, however, DCC and BEKK suggest holding crude oil futures to spot, but CCC and VARMA-GARCH suggest holding crude oil spot to futures. In addition, the calculated optimal hedge ratios (OHRs) from each multivariate conditional volatility model give the time-varying hedge ratios, and recommend to short in crude oil futures with a high proportion of one dollar long in crude oil spot. Finally, the hedging effectiveness indicates that DCC (BEKK) is the best (worst) model for OHR calculation in terms of reducing the variance of the portfolio.

Suggested Citation

  • Roengchai Tansuchat & Chia-Lin Chang & Michael McAleer, 2010. "Crude Oil Hedging Strategies Using Dynamic Multivariate GARCH," CIRJE F-Series CIRJE-F-704, CIRJE, Faculty of Economics, University of Tokyo.
    • Handle: RePEc:tky:fseres:2010cf704
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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