Pricing and hedging illiquid energy derivatives: an application to the JCC index

Authors: Scarpa E., Manera M.

Journal: Journal of Futures Markets

Publisher: Wiley-Blackwell

Year: 2009

Volume: 28

Pages: 464-487

Keywords: Hedging models, Cross-hedging, Energy derivatives, Illiquid financial products, Commodity markets, JCC price index

JEL: G13, G15

DOI: http://dx.doi.org/10.1002/fut.20296

 

Abstract

In this paper a simple strategy for pricing and hedging a swap on the Japanese crude oil cocktail (JCC) index is discussed. The empirical performance of different econometric models is compared in terms of their computed optimal hedge ratios, using monthly data on the JCC over the period January 2000–January 2006. An explanation to how to compute a bid/ask spread and to construct the hedging position for the JCC swap contract with variable oil volume is provided. The swap pricing scheme with backtesting and rolling regression techniques is evaluated. The empirical findings show that the price-level regression model permits one to compute more precise optimal hedge ratios relative to its competing alternatives.