The trade-off between liquidity and correlation: Proxy hedging of bunker fuel

Michael Coulon, Nina Lange, Diana Prinzbach

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    Abstract

    Fuel costs are a substantial component of the shipping industry, making bunker fuel price risk a major consideration for shipping firms. We analyse the hedging effectiveness of different proxy hedges with oil futures as well as OTC forwards for the bunker fuel market. Using different hedge ratios and a VECM-GARCH modeling approch it is found that oil futures’ hedging effectiveness has significantly improved over the past 20 years. Despite this improvement, in the minimum-variance framework, the forward contracts’ higher correlation still yields better hedging results. However, given the high amount of transaction costs for OTC products, the exchange-traded oil futures contracts can deliver higher mean-variance utilities and can thus be considered a viable candidate when hedging fuel for ships. We explore the tradeoff between liquidity and correlation that dominates this important energy market challenge.
    Original languageEnglish
    Publication date2018
    Publication statusPublished - 2018
    Event20th European Conference on Mathematics for Industry - Budapest, Hungary
    Duration: 18 Jun 201822 Jun 2018

    Conference

    Conference20th European Conference on Mathematics for Industry
    CountryHungary
    CityBudapest
    Period18/06/201822/06/2018

    Cite this

    Coulon, M., Lange, N., & Prinzbach, D. (2018). The trade-off between liquidity and correlation: Proxy hedging of bunker fuel. Abstract from 20th European Conference on Mathematics for Industry, Budapest, Hungary.