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Detecting market transitions and energy futures risk management using principal components

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  • Svetlana Borovkova

Abstract

An empirical approach to analysing the forward curve dynamics of energy futures is presented. For non-seasonal commodities—such as crude oil—the forward curve is well described by the first three principal components: the level, slope and curvature. A principal component indicator is described that detects transitions between the two fundamental market states remarkably well. For seasonal commodities—such as electricity and natural gas—it is shown how to extract the seasonal component from the forward curve. The principal component indicator can then be applied to the de-seasoned forward curve to detect significant price deviations that may support profitable trading strategies. A principal component approach to forward curve modelling is applied to computing portfolio value-at-risk. This approach is combined with a new two-step resampling procedure to improve value-at-risk estimates.

Suggested Citation

  • Svetlana Borovkova, 2006. "Detecting market transitions and energy futures risk management using principal components," The European Journal of Finance, Taylor & Francis Journals, vol. 12(6-7), pages 495-512.
    • Handle: RePEc:taf:eurjfi:v:12:y:2006:i:6-7:p:495-512
    DOI: 10.1080/13518470500377380
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    References listed on IDEAS

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    1. Hull, John & White, Alan, 1990. "Pricing Interest-Rate-Derivative Securities," The Review of Financial Studies, Society for Financial Studies, vol. 3(4), pages 573-592.
    2. David Heath & Robert Jarrow & Andrew Morton, 2008. "Bond Pricing And The Term Structure Of Interest Rates: A New Methodology For Contingent Claims Valuation," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 13, pages 277-305, World Scientific Publishing Co. Pte. Ltd..
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    Cited by:

    1. Margaret Insley, 2013. "On the timing of non-renewable resource extraction with regime switching prices: an optimal stochastic control approach," Working Papers 1302, University of Waterloo, Department of Economics, revised Aug 2013.
    2. Insley, Margaret, 2017. "Resource extraction with a carbon tax and regime switching prices: Exercising your options," Energy Economics, Elsevier, vol. 67(C), pages 1-16.
    3. Vázquez, Miguel & Sánchez-Úbeda, Eugenio F. & Berzosa, Ana & Barquín, Julián, 2008. "Short-term evolution of forward curves and volatility in illiquid power market," MPRA Paper 8932, University Library of Munich, Germany, revised May 2008.

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