Some Preliminary Considerations about Hedging Effectiveness for Crude Oil Market

All countries consume crude oil or oil products. Both producers and consumers are highly concerned about crude oil prices. The crude oil prices are being directly affecting by several factors such as economic, political, geopolitical, and technological, oil reserves, available stocks and weather conditions, among others. On other hand the crude oil prices fluctuations influence directly the world economy. Compared to the financial assets the crude oil prices have had an elevated volatility in recent years. Therefore, studies of crude oil prices movements and co-movements are highly complex. So the academics and practitioners are developing many studies about themes related with crude oil prices. The economic agents indirectly involved with crude oil negotiations, such as the planners of firms or governments, are looking for related petroleum prices forecasting models construction studies, while the agents directly involved are looking for the hedge strategies studies as well. The hedge strategies allow negotiators that have short and long positions in the market protection against prices fluctuations. This paper examines the performance of bivariate volatility models for the crude oil spot and futures returns of the Western Texas Intermediate – WTI type barrel prices. Besides the volatility of spot and future crude oil barrel returns time series, the hedge ratio strategy is examined through the hedge effectiveness. Thus this study show hedge strategies built using methodologies applied in the variance modeling of returns of crude oil prices in the spot, and future markets, and covariance between these two markets returns, which correspond to the inputs of the hedge strategy shown in this work. From the studied models, the chosen one was the bivariate GARCH in a Diagonal VECH representation. The methodologies used here take into consideration more realistic assumptions for the returns distribution more realistic than other methods that have been used in the financial literature: the heteroskedasticity and the non normality. The data used is logarithm returns of daily prices quoted in dollars per barrel from November 2008 to May 2010 for spot and future contracts, in particular the June contract.