Parameter Variation & the Components of Natural Gas Price Volatility

23 Pages Posted: 22 Apr 2015

See all articles by Matthew Brigida

Matthew Brigida

SUNY Institute of Technology at Utica/Rome - School of Management

Date Written: April 21, 2015

Abstract

Estimating a static coefficient for a deseasoned gas storage or weather variable implicitly assumes that market participants react identically throughout the year (and over each year) to that variable. In this analysis we model natural gas returns as a linear function of gas storage and weather variables, and we allow the coefficients of this function to vary continuously over time. This formulation takes into account that market participants continuously try to improve their forecasts of market prices, and this likely means they continuously change the scale of their reaction to changes in underlying variables. We use this model to also calculate conditional natural gas volatility and the proportion of volatility attributable to each factor. We find that return volatility is higher in the winter, and this increase is attributable to increases in the proportion of volatility due to weather and natural gas storage. We provide time series estimates of the changing proportion of volatility attributable to each factor, which is useful for hedging and derivatives trading in natural gas markets.

Suggested Citation

Brigida, Matthew, Parameter Variation & the Components of Natural Gas Price Volatility (April 21, 2015). USAEE Working Paper No. 15-210, Available at SSRN: https://ssrn.com/abstract=2597319 or http://dx.doi.org/10.2139/ssrn.2597319

Matthew Brigida (Contact Author)

SUNY Institute of Technology at Utica/Rome - School of Management ( email )

Utica, NY 13504
United States

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