The Performance of U.S. Futures Market in Hedging International Crude Oil

Abstract

We study the effectiveness of U.S. futures markets in hedging price risks in the international crude oil spot market. Three international markets, Australia, Canada and Mexico are selected. We devote our attention to three hedging strategies: hedge a spot position that does not recognize native currency exchange rate fluctuations with a single commodity futures position; hedge a spot position that does recognize native currency exchange rate fluctuations with a single commodity futures position; hedge a spot position that does recognize native currency exchange rate fluctuations with both commodity and currency futures positions. Three base hedge ratio estimation models are developed based on these three hedging strategies. We compare the effectiveness of these hedging strategies over each of the three hedging horizons, one week, four weeks and twelve weeks for each country. Empirical hedge ratio estimation models are selected to deal with seasonality, auto correlation and heteroscedasticity. Hedge effectiveness is properly estimated by comparing hedged and unhedged outcome variances of the auto regression-corrected and/or heteroscedasticity-corrected transformed data.