Hedging the Counterparty Credit Risk of an Oil Company with Oil Futures Using Dynamic GARCH – A Derivative's Approach to Right-Way Risk

21 Pages Posted: 10 Jan 2014

See all articles by Frank Lehrbass

Frank Lehrbass

L*PARC (Lehrbass Predicitive Analytics and Risk Consulting); FOM University of Applied Sciences for Economics and Management; University of the Bundesbank

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Date Written: January 09, 2014

Abstract

If the creditworthiness of a counterparty is a derivative of a commodity price, there is the potential to have right- or wrong-way exposures in respective commodity transaction. Identifying them is important, because otherwise credit costs might be inadequately calculated and wrong incentives might be set. This is especially important if one wants to do more business in credit risky areas of the world.

As concerns publicly listed counterparties I develop a simple approach for identification of "Right Way Risk" (RWR). This approach only works if the stock and commodity price are co-integrated. To set the stage I subsume various models for optimal hedging under one general co-integrated model. In a worked example three models (Bivariate & Univariate Error Correction Model, Conventional Regression Model) are applied to the Chinese oil company Petrochina and RWR is shown for fixed price purchase contracts. The proposed approach might be useful in getting a more accurate picture of credit risk and to structure commodity transactions more rewardingly.

Keywords: Corporate risk management, right-way risk, dynamic bivariate GARCH, ECM, cointegrated system, optimal hedging

JEL Classification: C3, C5, D2, F1, F2, F3, G1, G13, G3, G32, L1, M1, M2

Suggested Citation

Lehrbass, Frank, Hedging the Counterparty Credit Risk of an Oil Company with Oil Futures Using Dynamic GARCH – A Derivative's Approach to Right-Way Risk (January 09, 2014). Available at SSRN: https://ssrn.com/abstract=2377193 or http://dx.doi.org/10.2139/ssrn.2377193

Frank Lehrbass (Contact Author)

L*PARC (Lehrbass Predicitive Analytics and Risk Consulting) ( email )

Dusseldorf
Germany

HOME PAGE: http://lehrbass.de

FOM University of Applied Sciences for Economics and Management ( email )

Toulouser Allee 53
Dusseldorf, 40476
Germany

University of the Bundesbank ( email )

Schloss
Hachenburg, 57627
Germany

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