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

28 Pages Posted: 14 Jun 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: June 12, 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 commodity transaction. Identifying them is important, because otherwise credit costs are inadequately calculated. 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 cointegrated. To set the stage I subsume various models for optimal hedging under one general cointegrated model. In a worked example three models (Bivariate & Univariate Error Correction Model, Regression Model) are applied to the Chinese oil company Petrochina and RWR is shown for fixed price purchase contracts. The approach might help to get an accurate picture of credit risk and to structure commodity transactions more rewardingly.

Keywords: corporate risk management, right-way risk, GARCH, ECM, cointegrated system

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 (June 12, 2014). USAEE Working Paper No. 14-164. Available at SSRN: https://ssrn.com/abstract=2449239 or http://dx.doi.org/10.2139/ssrn.2449239

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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