IDEAS home Printed from https://ideas.repec.org/a/eee/eneeco/v63y2017icp174-184.html
   My bibliography  Save this article

Pure martingale and joint normality tests for energy futures contracts

Author

Listed:
  • Shrestha, Keshab
  • Subramaniam, Ravichandran
  • Rassiah, Puspavathy

Abstract

In this study, we empirically analyze to see if the pure martingale hypothesis holds for three energy-related commodities: crude oil, heating oil and natural gas. We also test this hypothesis for five different hedging horizons: 1-day, 1-week, 4-week, 8-week and 12-week. Our empirical results show that the pure martingale hypothesis holds for all three commodities and all five horizons. This implies that the expected return on futures contract can be ignored in determining the optimal hedge ratio. We also test to see if the joint normality between futures and spot returns holds for the same three commodities and five hedging horizons. We reject the joint normality hypothesis for all three commodities and five hedging horizons. This implies that hedgers with different utility function have different optimal hedge ratios. Thus, in general, one needs to take into account of hedger's utility function when deriving optimal hedge ratio. Our results are robust to pre- and post-financial crisis as well as some other specifications considered in the paper.

Suggested Citation

  • Shrestha, Keshab & Subramaniam, Ravichandran & Rassiah, Puspavathy, 2017. "Pure martingale and joint normality tests for energy futures contracts," Energy Economics, Elsevier, vol. 63(C), pages 174-184.
  • Handle: RePEc:eee:eneeco:v:63:y:2017:i:c:p:174-184
    DOI: 10.1016/j.eneco.2017.02.005
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0140988317300439
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Donald Lien & Yiu Kuen Tse, 2000. "Hedging downside risk with futures contracts," Applied Financial Economics, Taylor & Francis Journals, vol. 10(2), pages 163-170.
    2. Leland L. Johnson, 1960. "The Theory of Hedging and Speculation in Commodity Futures," Review of Economic Studies, Oxford University Press, vol. 27(3), pages 139-151.
    3. Donald Lien & Xiangdong Luo, 1993. "Estimating the extended mean‐gini coefficient for futures hedging," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 13(6), pages 665-676, September.
    4. Cotter, John & Hanly, Jim, 2015. "Performance of utility based hedges," Energy Economics, Elsevier, vol. 49(C), pages 718-726.
    5. Cecchetti, Stephen G & Cumby, Robert E & Figlewski, Stephen, 1988. "Estimation of the Optimal Futures Hedge," The Review of Economics and Statistics, MIT Press, vol. 70(4), pages 623-630, November.
    6. Martínez, Beatriz & Torró, Hipòlit, 2015. "European natural gas seasonal effects on futures hedging," Energy Economics, Elsevier, vol. 50(C), pages 154-168.
    7. K. C. Chen & R. Stephen Sears & Dah‐Nein Tzang, 1987. "Oil prices and energy futures," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 7(5), pages 501-518, October.
    8. Chen, Sheng-Syan & Lee, Cheng-few & Shrestha, Keshab, 2008. "Do the pure martingale and joint normality hypotheses hold for futures contracts: Implications for the optimal hedge ratios," The Quarterly Review of Economics and Finance, Elsevier, vol. 48(1), pages 153-174, February.
    9. 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.
    10. Kroner, Kenneth F. & Sultan, Jahangir, 1993. "Time-Varying Distributions and Dynamic Hedging with Foreign Currency Futures," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(4), pages 535-551, December.
    11. Pan, Zhiyuan & Wang, Yudong & Yang, Li, 2014. "Hedging crude oil using refined product: A regime switching asymmetric DCC approach," Energy Economics, Elsevier, vol. 46(C), pages 472-484.
    12. Tae H. Park & Lorne N. Switzer, 1995. "Bivariate GARCH estimation of the optimal hedge ratios for stock index futures: A note," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 15(1), pages 61-67, February.
    13. Haim Shalit, 1995. "Mean‐Gini hedging in futures markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 15(6), pages 617-635, September.
    14. Robert W. Kolb & John Okunev, 1993. "Utility maximizing hedge ratios in the extended mean gini framework," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 13(6), pages 597-609, September.
    15. C. Sherman Cheung & Clarence C. Y. Kwan & Patrick C. Y. Yip, 1990. "The hedging effectiveness of options and futures: A mean‐gini approach," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 10(1), pages 61-73, February.
    16. Abe De Jong & Frans De Roon & Chris Veld, 1997. "Out‐of‐sample hedging effectiveness of currency futures for alternative models and hedging strategies," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 17(7), pages 817-837, October.
    17. Conlon, Thomas & Cotter, John, 2013. "Downside risk and the energy hedger's horizon," Energy Economics, Elsevier, vol. 36(C), pages 371-379.
    18. Coulon, Michael & Powell, Warren B. & Sircar, Ronnie, 2013. "A model for hedging load and price risk in the Texas electricity market," Energy Economics, Elsevier, vol. 40(C), pages 976-988.
    19. Robert W. Kolb & John Okunev, 1992. "An empirical evaluation of the extended mean‐gini coefficient for futures hedging," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 12(2), pages 177-186, April.
    20. Chen, Sheng-Syan & Lee, Cheng-few & Shrestha, Keshab, 2003. "Futures hedge ratios: a review," The Quarterly Review of Economics and Finance, Elsevier, vol. 43(3), pages 433-465.
    21. Donald Lien & Yiu Kuen Tse, 1998. "Hedging time‐varying downside risk," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 18(6), pages 705-722, September.
    22. Ederington, Louis H. & Salas, Jesus M., 2008. "Minimum variance hedging when spot price changes are partially predictable," Journal of Banking & Finance, Elsevier, vol. 32(5), pages 654-663, May.
    23. Shrestha, Keshab, 2014. "Price discovery in energy markets," Energy Economics, Elsevier, vol. 45(C), pages 229-233.
    24. Alexander, Carol & Prokopczuk, Marcel & Sumawong, Anannit, 2013. "The (de)merits of minimum-variance hedging: Application to the crack spread," Energy Economics, Elsevier, vol. 36(C), pages 698-707.
    25. Paul A. Samuelson, 1973. "Proof That Properly Discounted Present Values of Assets Vibrate Randomly," Bell Journal of Economics, The RAND Corporation, vol. 4(2), pages 369-374, Autumn.
    26. Frestad, Dennis, 2012. "Liquidity and dirty hedging in the Nordic electricity market," Energy Economics, Elsevier, vol. 34(5), pages 1341-1355.
    27. Lien, Donald & Tse, Y K, 2002. "Some Recent Developments in Futures Hedging," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 357-396, July.
    28. Chin‐Wen Hsln & Jerry Kuo & Cheng‐Few Lee, 1994. "A new measure to compare the hedging effectiveness of foreign currency futures versus options," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 14(6), pages 685-707, September.
    29. Adams, Zeno & Gerner, Mathias, 2012. "Cross hedging jet-fuel price exposure," Energy Economics, Elsevier, vol. 34(5), pages 1301-1309.
    30. 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.
    31. Ronald D. Ripple & Imad A. Moosa, 2007. "Hedging effectiveness and futures contract maturity: the case of NYMEX crude oil futures," Applied Financial Economics, Taylor & Francis Journals, vol. 17(9), pages 683-689.
    32. Cotter, John & Hanly, Jim, 2012. "A utility based approach to energy hedging," Energy Economics, Elsevier, vol. 34(3), pages 817-827.
    33. Sheng‐Syan Chen & Cheng‐Few Lee & Keshab Shrestha, 2001. "On a Mean—Generalized Semivariance Approach to Determining the Hedge Ratio," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 21(6), pages 581-598, June.
    34. Sheng‐Syan Chen & Cheng‐Few Lee & Keshab Shrestha, 2004. "An empirical analysis of the relationship between the hedge ratio and hedging horizon: A simultaneous estimation of the short‐ and long‐run hedge ratios," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 24(4), pages 359-386, April.
    35. Mingfeng Lin & Henry C. Lucas & Galit Shmueli, 2013. "Research Commentary ---Too Big to Fail: Large Samples and the p -Value Problem," Information Systems Research, INFORMS, vol. 24(4), pages 906-917, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Dong, Kangyin & Dong, Xiucheng & Ren, Xiaohang, 2020. "Can expanding natural gas infrastructure mitigate CO2 emissions? Analysis of heterogeneous and mediation effects for China," Energy Economics, Elsevier, vol. 90(C).
    2. Shrestha, Keshab & Subramaniam, Ravichandran & Peranginangin, Yessy & Philip, Sheena Sara Suresh, 2018. "Quantile hedge ratio for energy markets," Energy Economics, Elsevier, vol. 71(C), pages 253-272.
    3. Yingying Xu & Donald Lien, 2020. "Optimal futures hedging for energy commodities: An application of the GAS model," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 40(7), pages 1090-1108, July.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Shrestha, Keshab & Subramaniam, Ravichandran & Peranginangin, Yessy & Philip, Sheena Sara Suresh, 2018. "Quantile hedge ratio for energy markets," Energy Economics, Elsevier, vol. 71(C), pages 253-272.
    2. Jui-Cheng Hung & Chien-Liang Chiu & Ming-Chih Lee, 2006. "Hedging with zero-value at risk hedge ratio," Applied Financial Economics, Taylor & Francis Journals, vol. 16(3), pages 259-269.
    3. Barbi, Massimiliano & Romagnoli, Silvia, 2018. "Skewness, basis risk, and optimal futures demand," International Review of Economics & Finance, Elsevier, vol. 58(C), pages 14-29.
    4. George E. Halkos & Apostolos S. Tsirivis, 2019. "Energy Commodities: A Review of Optimal Hedging Strategies," Energies, MDPI, Open Access Journal, vol. 12(20), pages 1-19, October.
    5. Martínez, Beatriz & Torró, Hipòlit, 2015. "European natural gas seasonal effects on futures hedging," Energy Economics, Elsevier, vol. 50(C), pages 154-168.
    6. Wenming Shi & Kevin X. Li & Zhongzhi Yang & Ganggang Wang, 2017. "Time-varying copula models in the shipping derivatives market," Empirical Economics, Springer, vol. 53(3), pages 1039-1058, November.
    7. Furió, Dolores & Torró, Hipòlit, 2020. "Optimal hedging under biased energy futures markets," Energy Economics, Elsevier, vol. 88(C).
    8. Kuang-Liang Chang, 2011. "The optimal value-at-risk hedging strategy under bivariate regime switching ARCH framework," Applied Economics, Taylor & Francis Journals, vol. 43(21), pages 2627-2640.
    9. Chai, Shanglei & Zhou, P., 2018. "The Minimum-CVaR strategy with semi-parametric estimation in carbon market hedging problems," Energy Economics, Elsevier, vol. 76(C), pages 64-75.
    10. Darren Butterworth & Phil Holmes, 2005. "The Hedging Effectiveness of U.K. Stock Index Futures Contracts Using an Extended Mean Gini Approach: Evidence for the FTSE 100 and FTSE Mid250 Contracts," Multinational Finance Journal, Multinational Finance Journal, vol. 9(3-4), pages 131-160, September.
    11. Lim, Siew Hoon & Turner, Peter A., 2016. "Airline Fuel Hedging: Do Hedge Horizon and Contract Maturity Matter?," Journal of the Transportation Research Forum, Transportation Research Forum, vol. 55(1), April.
    12. Martínez, Beatriz & Torró, Hipòlit, 2018. "Hedging spark spread risk with futures," Energy Policy, Elsevier, vol. 113(C), pages 731-746.
    13. Cotter, John & Hanly, Jim, 2015. "Performance of utility based hedges," Energy Economics, Elsevier, vol. 49(C), pages 718-726.
    14. Olson, Eric & Vivian, Andrew & Wohar, Mark E., 2019. "What is a better cross-hedge for energy: Equities or other commodities?," Global Finance Journal, Elsevier, vol. 42(C).
    15. Bessler, Wolfgang & Leonhardt, Alexander & Wolff, Dominik, 2016. "Analyzing hedging strategies for fixed income portfolios: A Bayesian approach for model selection," International Review of Financial Analysis, Elsevier, vol. 46(C), pages 239-256.
    16. Hung, Jui-Cheng, 2015. "Evaluation of realized multi-power variations in minimum variance hedging," Economic Modelling, Elsevier, vol. 51(C), pages 672-679.
    17. Jim Hanly, 2017. "Managing Energy Price Risk using Futures Contracts: A Comparative Analysis," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3).
    18. 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.
    19. Асатуров К.Г. & Теплова Т.В., 2014. "Построение Коэффициентов Хеджирования Для Высоколиквидных Акций Российского Рынка На Основе Моделей Класса Garch," Журнал Экономика и математические методы (ЭММ), Центральный Экономико-Математический Институт (ЦЭМИ), vol. 50(1), pages 37-54, январь.
    20. Ubukata, Masato, 2018. "Dynamic hedging performance and downside risk: Evidence from Nikkei index futures," International Review of Economics & Finance, Elsevier, vol. 58(C), pages 270-281.

    More about this item

    Keywords

    Hedge ratio; Pure martingale; Joint normality;
    All these keywords.

    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • G1 - Financial Economics - - General Financial Markets
    • Q4 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:eneeco:v:63:y:2017:i:c:p:174-184. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Haili He). General contact details of provider: http://www.elsevier.com/locate/eneco .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.