The risk premia of energy futures (original) (raw)

Modeling, Risk Assessment and Portfolio Optimization of Energy Futures

This paper examines the portfolio optimization of energy futures by using the STARR ratio that can evaluate the risk and return relationship for skewed distributed returns. We model the price returns for energy futures by using the ARMA(1,1)-GARCH(1,1)-PCA model with stable distributed innovations that reflects the characteristics of energy: mean reversion, heteroskedasticity, seasonality, and spikes. Then, we propose the method for selecting the portfolio of energy futures by maximizing the STARR ratio, what we call "Winner portfolio". The empirical studies by using energy futures of WTI crude oil, heating oil, and natural gas traded on the NYMEX compare the price return models with stable distributed innovations to those with normal ones.

Portfolio optimization of financial commodities with energy futures

Annals of Operations Research

The recent growth in economic and financial markets has brought the focus on energy derivatives as an alternative investment class for investors, financial analysts, and portfolio managers. The financial modeling and risk management of portfolios using the energy derivatives instrument is a requirement and challenge for researchers in the field. The energy and other commodity futures force the expert investors to investigate the broader investment spectrum and consequently diversify their portfolios using the futures instruments. Going beyond the conventional portfolios and developing out-of-the-box strategies that comply with the changing financial and economic advancements are the keys to long-term sustainability in the financial world. This study investigates the impact of diversification with five energy futures from January 2011 to July 2020 on three traditional commodity futures portfolios. The results show that diversification increased the returns while simultaneously reducing the portfolio volatility in all portfolios. The diversified portfolios provided higher returns than the traditional portfolios for the same level of risk. This study also revealed that the results might improve when a short position in the futures contracts is allowed. Moreover, we conclude

Capturing the risk premium of commodity futures: The role of hedging pressure

Journal of Banking & Finance, 2013

We construct long-short factor-mimicking portfolios that capture the hedging pressure risk premium of commodity futures. We consider single sorts based on the open interests of either hedgers or speculators, as well as double sorts based on both positions. We find positive and significant commodity futures risk premiums from both single and double sorts, alongside with Sharpe ratios that systematically exceed those of long-only commodity portfolios. Further tests show that the hedging pressure risk premiums rise with the lagged volatility of commodity markets and that the cross-sectional price of commodity risk is positive. Finally, the hedging pressure risk premiums are found to explain the performance of active commodity portfolios better than long-only commodity benchmarks and to act as better diversifiers of equity risk.

Energy Commodities: A Review of Optimal Hedging Strategies

Energies, 2019

Energy is considered as a commodity nowadays and continuous access along with price stability is of vital importance for every economic agent worldwide. The aim of the current review paper is to present in detail the two dominant hedging strategies relative to energy portfolios, the Minimum-Variance hedge ratio and the expected utility maximization methodology. The Minimum-Variance hedge ratio approach is by far the most popular in literature as it is less time consuming and computationally demanding; nevertheless by applying the appropriate multivariate model Garch family volatility model, it can provide a very reliable estimation of the optimal hedge ratio. However, this becomes possible at the cost of a rather restrictive assumption for infinite hedger's risk aversion. Within an uncertain worldwide economic climate and a highly volatile energy market, energy producers, retailers and consumers had to become more adaptive and develop the necessary energy risk management and optimal hedging strategies. The estimation gap of an optimal hedge ratio that would be subject to the investor's risk preferences through time is filled by the relatively more complex and sophisticated expected utility maximization methodology. Nevertheless, if hedgers share infinite risk aversion or if alternatively the expected futures price is approximately zero the two methodologies become equivalent. The current review shows that when evidence from the energy market during periods of extremely volatile economic climate is considered, both hypotheses can be violated, hence it becomes reasonable that especially for extended hedging horizons it would be wise for potential hedgers to take into consideration both methodologies in order to build a successful and profitable hedging strategy.

Portfolio diversification in energy markets

Energy Economics, 2010

This paper's results indicate that futures for crude oil, natural gas and unleaded gasoline fail to enhance the performance of representative energy stocks in terms of return to risk, but do decrease the overall level of risk exposure borne by passive equity investors. Our …ndings suggest that futures contracts on energy commodities are valuable to market participants with an interest in hedging against price ‡uctuations in energy markets by buy-and-hold strategies. However, this conclusion is reversed when one takes the perspective of traders whose core interests can be better approximated through the return to risk-bearing. In fact, this paper documents that return-to-risk maximizing agents are unlikely to pro…t from trading energy futures in addition to energy stocks. Moreover, futures for energy commodities fail to o¤er signi…cant diversi…cation gains with respect to energy stocks once investors adopt simple dynamic trading strategies that rely on readily available pricing information.

Downside risk and the energy hedger's horizon

Energy Economics, 2013

In this paper, we explore the impact of investor time-horizon on an optimal downside hedged energy portfolio. Previous studies have shown that minimum-variance hedging effectiveness improves for longer horizons using variance as the performance metric. This paper investigates whether this result holds for different hedging objectives and effectiveness measures. A wavelet transform is applied to calculate the optimal heating oil hedge ratio using a variety of downside objective functions at different time-horizons. We demonstrate decreased hedging effectiveness for increased levels of uncertainty at higher confidence intervals. Moreover, for each of the different hedging objectives and effectiveness measures studied, we also demonstrate increasing hedging effectiveness at longer horizons. While small differences in effectiveness are found across the different hedging objectives, timehorizon effects are found to dominate confirming the importance of considering the hedgers horizon. The findings suggest that while downside risk measures are useful in the computation of an optimal hedge ratio that accounts for unwanted negative returns, hedging horizon and confidence intervals should also be given careful consideration by the energy hedger.

An Anatomy of Commodity Futures Risk Premia

The Journal of Finance, 2014

We identify two types of risk premia in commodity futures returns: spot premia related to the risk in the underlying commodity, and term premia related to changes in the basis. Sorting on forecasting variables such as the futures basis, return momentum, volatility, inflation, hedging pressure, and liquidity results in sizable spot premia between 5% and 14% per annum and term premia between 1% and 3% per annum. We show that a single factor, the high-minus-low portfolio from basis sorts, explains the cross-section of spot premia. Two additional basis factors are needed to explain the term premia.

The efficacy of financial futures as a hedging tool in electricity markets

International Journal of Finance & Economics

This paper estimates and applies a risk management strategy for electricity spot exposures using futures hedging. We apply our approach to three of the most actively traded European electricity markets, Nordpool, APXUK and Phelix. We compare both optimal hedging strategies and the hedging effectiveness of these markets for two hedging horizons, weekly and monthly using both Variance and Value at Risk (VaR). Our key finding is that electricity futures can effectively manage risk only for specific time periods when using hedging strategies that have been very successful in financial and other commodity markets. More generally they are ineffective as a risk management tool when compared with other energy assets. This is especially true at the weekly frequency. We also find significant differences in both the Optimal Hedge Ratios (OHR's) and the hedging effectiveness of the different electricity markets. Better performance is found for the Nordpool market, while the poorest performer in hedging terms is the Phelix market.

Futures hedging and risk management

2021

This dissertation was written as a part of the MSc in Energy and Finance at the International Hellenic University. Based on the recent literature, on this paper we focus on the effectiveness of different hedging strategies, both constant hedge ratio and time-varying hedge ratio, on natural gas prices in the United States. Natural gas prices fluctuate depending on seasons. To examine how these fluctuations affect the hedging ability of the econometric models we use we conduct an analysis regarding seasons (fall-winter, springsummer) and regarding market conditions (contango-backwardation). The analysis is conducted over different various time horizons (weekly-monthly). We complete this study by presenting the economic-financial benefits of using these hedging strategies in order to assess the impact of volatility in monetary values.

Hedging Pressure and Returns in Futures: Evidence Across Asset Classes

2018

The hedging pressure hypothesis contends that commodity futures prices depend on the net positions of hedgers. This paper adopts a time-series and cross-sectional analysis to revisit this hypothesis in the context of commodity markets and additionally to test its empirical validity in equity, currency and fixed income futures markets. Our analysis provides evidence of a significant hedging pressure risk premium in commodity, equity and currency futures markets. The premium correlates with general market movements and with the well-known momentum and carry factors and increases in economic conditions, consistent with the concurrence of greater hedging demand and a lessening of speculator capital flows. In contrast with the currency and fixed income factors, we find that the commodity and equity hedging pressure factors have crosssectional pricing ability across asset classes, beyond traditional risk factors. JEL classifications: G13, G14