Palgo Journl of Business Management

Vol. 4(2) pp.111 -118, August, 2017.

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FULL LENGTH RESEARCH

THE HEDGING EFFECTIVENESS OF THE OPTIMAL HEDGE RATIO FOR CRUDE OIL, GASOLINE AND HEATING OIL

Don Charles and Martin Franklin

Department of Economics at the University of the West Indies, St. Augustine Campus.

Email:doncharles005@gmail.com

Accepted 20 August, 2017

Abstract

Crude oil and refinery fraction prices are volatile. The literature has suggested hedging as one of the means to address such volatility. Most methods for hedging can be categorized as Ordinary Least Squares (OLS) based, Cointegration based, or Volatility based.
This study sought to compute and compare various methods for the optimal hedge ratio (OHR) for crude oil, gasoline and heating oil.Data on the spot and futures prices of crude oil, gasoline and heating oil were obtained from the Energy Information Administration (US EIA) database. The optimal hedge is estimated by the methods of OLS, Cointegration based Regression, Volatility based Regression, and the Kalman Filter to facilitate a comparison of the effectiveness of the hedging methods employed. This study makes a contribution to the literature as it proposes a new method to assess hedging effectiveness based on changing the OHR into a portfolio weight and minimizing the variance of the portfolio.

Keywords: Hedging Effectiveness, Optimal Hedge Ratio, Petroleum Prices 

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