The (de)merits of minimum-variance hedging: Application to the crack spread

Volatility and Risk Management in European Electricity Futures Markets

“…The relatively poor performance of the CCGARCH model may relate to an inability of GARCH models to handle large and frequent jumps in the basis as are typical for electricity markets. This has been found by other studies for even less volatile series such as Oil (Alexander, Prokopczuk and Sumawong, 2013) and Equities (Lee and Yoder, 2007). From these results we conclude that an OLS model is perfectly adequate in that it provides the best chance of obtaining good hedging effectiveness.…”

“…In this paper we adopt the variance minimisation approach given the widespread use of the variance as a risk measure; its dominance in the hedging literature and its twin advantages of relative ease of calculation and interpretation. It also allows us to draw comparisons between the hedging effectiveness of electricity futures and the hedging effectiveness of other energy assets which many papers (see for example, El-Khoury, 2007, Alexander, Prokopczuk andSumawong, 2013) have examined using the variance minimisation paradigm.…”

What is a better cross-hedge for energy: Equities or other commodities?

“…Alizadeh and colleagues (2008) find that the optimal hedge ratio from a Markov regime-switching BGARCH (RS-GARCH) model outperforms the naïve strategy and time-invariant optimal hedge ratios. Alexander, Prokopczuk, and Sumawong (2013) conduct an extensive out-of-sample study of minimumvariance hedging for a complex underlying position, the crack spread. They use several hedging approaches and covariance estimation techniques, which are compared with a simple naïve hedge, explicitly taking into account margin and transaction costs, which are not explicitly modelled in most previous work.…”

European natural gas seasonal effects on futures hedging

“…The paper finishes with conclusions and cited references. Alexander et al (2013) argue that the minimum variance (MV henceforth) framework has several advantages over optimal hedging (OH henceforth). OH is based in normality or meanvariance utility functions.…”