Proxy Hedging of Commodities: Hedging Gasoil Commitments in Related Futures Markets

Cecilie Viken & Marianne Solem Thorsrud

Student thesis: Master thesis


The German gasoil market does not have an existent liquid futures market. In order to hedge risks in this market, other correlated markets must be used for hedging. We look at proxy hedges using both Brent crude oil futures and ARA gasoil futures, when trying to reduce spot price risks in the formerly mentioned German gasoil market. A 3-factor model is introduced, where the spot price and the convenience yield are modeled as stochastic, and the log spread between the illiquid spot price and the futures price used to hedge is modeled as a mean-reverting OU process. This model is estimated through a Kalman ltering method. When modeling the log spread as an OU-process, we implicitly assume a stationary distribution of the log spread and thereby indirectly account for a long-term cointegration relationship between the spot price being hedged and the futures price used to hedge. Di erent hedging strategies are tested on the prices that are simulated through the 3-factor model. These hedging strategies include a regression based minimum variance hedge, a parameter-based minimum variance hedge, log and quadratic utility hedges and a na ve hedge. These hedges are then compared to the strategy without any hedge. Ederington's measure of e ectiveness and Value-at-Risk are computed to check the quality of the results. We nally test our hedging strategies on a speci c case, where DONG Energy is committed to buy German gasoil in the spot market. The hedges are tested on a contract price based on the spot price of German gasoil. Our results show great e ectiveness in both markets, but ARA gasoil futures are more e ective in reducing the risks coming from the German gasoil market. We also nd that a static hedging strategy is more e ective than both static rolling and semidynamic strategies. This also holds for the case applied to DONG Energy, a large Danish energy company hedging against price risk in the German gasoil market.

EducationsMSc in Advanced Economics and Finance, (Graduate Programme) Final Thesis
Publication date2013
Number of pages165