Hedging crude oil during shocks

Abstract

Crude oil is a valuable commodity that significantly impacts the global economy. Therefore, protecting against the risks associated with its price volatility is necessary. This thesis focuses on regime shift periods and the structural breaks in the oil price. We do this by focusing on seven historical events significantly influencing the oil price's volatility structure. The models we use are naïve 1-to-1 hedge, OLS, standard GARCH, GJR-GARCH, and exponential GARCH. We find the minimum variance hedge ratio of hedge portfolios and that no model outperforms the others. We see that to estimate the volatility accurately, it is crucial to consider the characteristics of the given historical event. Additionally, imposing a perfect correlation between spot and futures diminishes the model's efficacy, emphasizing the significance of precisely measuring their correlation when selecting an appropriate strategy for an oil shock.