Dynamic Hedging Strategies: An Application to the Crude Oil Market

45 Pages Posted: 11 Mar 2010  

Delphine Lautier

University Paris Dauphine

Alain G. Galli

Cerna Mines-Paristech

Date Written: March 10, 2010

Abstract

This article analyses long-term dynamic hedging strategies relying on term structure models of commodity prices and proposes a new way to calibrate the models which takes into account the error associated with the hedge ratios. Different strategies, with maturities up to seven years, are tested on the American crude oil futures market. The study considers three recent and efficient models respectively with one, two, and three factors. The continuity between the models makes it possible to compare their performances which are judged on the basis of the errors associated with a delta hedge. The strategies are also tested for their sensitivity to the maturities of the positions and to the frequency of the portfolio rollover. We found that our method gives the best of two seemingly incompatible worlds: the higher liquidity of short-term futures contracts for the hedge portfolios, together with markedly improved performances. Moreover, even if it is more complex, the three-factor model is by far, the best.

Keywords: Dynamic Hedging, Commodities, Futures, Long-term commitment, Calibration

JEL Classification: G13, C13, C52, Q49

Suggested Citation

Lautier, Delphine and Galli, Alain G., Dynamic Hedging Strategies: An Application to the Crude Oil Market (March 10, 2010). Available at SSRN: https://ssrn.com/abstract=1568019 or http://dx.doi.org/10.2139/ssrn.1568019

Delphine Lautier

University Paris Dauphine ( email )

place du Maréchal de Lattre de Tassigny
cedex 16
Paris, 75775
France

Alain G. Galli (Contact Author)

Cerna Mines-Paristech ( email )

60 bd St Michel
Paris, 75006
France

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