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Volatility and the Hedging Effectiveness of China Fuel Oil Futures

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  • Wei Chen
  • J L Ford

Abstract

This paper is an original study of the volatility in China’s oil fuel spot and futures markets, and in the spot market of Singapore one of China’s main source of imports. GARCH(1,1), TGARCH(1,1) and a constant variance model are estimated using 500 daily observations from 25 August 2005. The optimum hedge ratios derived from the competing models are evaluated in terms of the variance and semi-variance (downside) risk that they promise compared with a no-hedge portfolio: and also in terms of their expected utility. This is also accomplished for hedging in the Singapore market. Out-of-sample observations (54) are used to up-date, day-by-day, the variance-covariance matrices from the estimation period. The findings are used to compare the competing models, and the two hedging strategies, over that extended period. They showed the stability of the original estimates and of the ranking of the models under any given criterion. Hedging in China’s market is more effective in terms of reducing downside risk and maximising expected utility than is hedging in Singapore’s market. The latter dominates in terms of variance reduction.

Suggested Citation

  • Wei Chen & J L Ford, 2010. "Volatility and the Hedging Effectiveness of China Fuel Oil Futures," Discussion Papers 10-15, Department of Economics, University of Birmingham.
    • Handle: RePEc:bir:birmec:10-15
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    File URL: https://repec.cal.bham.ac.uk/pdf/10-15.pdf
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    References listed on IDEAS

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    1. Chris Brooks & Olan T. Henry & Gita Persand, 2002. "The Effect of Asymmetries on Optimal Hedge Ratios," The Journal of Business, University of Chicago Press, vol. 75(2), pages 333-352, April.
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    More about this item

    Keywords

    China's fuel oil spot and futures returns; Singapore's spot market; volatility; bivariate GARCH and TGARCH; hedged portfolio returns; variance reduction; downside risk; expected utility;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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