Volatility dynamics of nymex natural gas futures prices

Abstract

Despite their importance in pricing futures and other derivative contracts, seasonalvariations in mean and variance of energy prices have not been fully captured inprevious studies of energy prices. We examine the volatility dynamics of daily naturalgas futures traded on the NYMEX via the partially overlapping time-series (POTS) modelof Smith (2005, Journal of Applied Econometrics). We illustrate that the volatility of dailyprice changes of natural gas exhibits strong seasonality, even as the volatility increases asa contract approaches its expiration, a time-to-maturity effect. Our analysis reveals thatthe persistence of price shocks and, hence, the correlations among concurrently tradedcontracts, also exhibit substantial seasonal and cross-sectional variation. These volatilitypatterns we estimate are closely related to the seasonal cycle of US natural gas storage ina way consistent with the theory of storage. We demonstrate that, by ignoring theseasonality in the volatility dynamics of natural gas futures prices, previous studies havesuggested sub-optimal hedging strategies.