Dealing with Downside Risk in Energy Markets: Futures versus Exchange-Traded Funds

The emergence of energy exchange-traded funds (ETFs) has provided an alternative vehicle for both energy producers and users to hedge their respective exposures to unfavorable energy price movements without opening a relative expensive futures account. While hedging with energy ETFs has been touted as a promising alternative to hedging with traditional energy futures, the question concerning the hedging effectiveness of energy ETFs versus energy futures, especially in terms of their ability to manage downside risk, remains largely unexplored. Accordingly, this study formally compares the hedging effectiveness of the two instruments in a downside risk framework from the perspective of both short and long hedgers. Two estimation methods are applied to estimate the minimum-Value at Risk (VaR) and minimum-Expected Shortfall (ES) hedge ratios: the empirical distribution function method and the kernel copula method. The empirical application focuses on four different energy commodities: crude oil, gasoline, heating oil, and natural gas.