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    Volatility dynamics and seasonality in energy prices: implications for crack-spread price risk

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    Authors
    Suenaga, Hiroaki
    Smith, A.
    Date
    2011
    Type
    Journal Article
    
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    Citation
    Suenaga, Hiroaki and Smith, Aaron. 2011. Volatility dynamics and seasonality in energy prices: implications for crack-spread price risk. Energy Journal. 32 (3): pp. 27-58.
    Source Title
    Energy Journal
    DOI
    10.5547/ISSN0195-6574-EJ-Vol32-No3-2
    ISSN
    0195-6574
    School
    School of Economics and Finance
    URI
    http://hdl.handle.net/20.500.11937/3163
    Collection
    • Curtin Research Publications
    Abstract

    We examine the volatility dynamics of three major petroleum commodities traded on the NYMEX: crude oil, unleaded gasoline, and heating oil. Using the partially overlapping time-series (POTS) framework of Smith (2005), we model jointly all futures contracts with delivery dates up to a year into the future and extract information from these prices about the persistence of market shocks. The model depicts highly nonlinear volatility dynamics that are consistent with the observed seasonality in demand and storage of the three commodities. Specifically, volatility of the three commodity prices exhibits time-to-delivery effects and substantial seasonality, yet their patterns vary systematically by contract delivery month. The conditional variance and correlation across the three commodities also vary over time. High price volatility of near-delivery contracts and their low correlation with concurrently traded distant contracts imply high short-horizon price risk for an unhedged position in the calendar or crack spread. Price risk at the one-year horizon is much lower than short-horizon risk in all seasons and for all positions, but it is still substantial in magnitude for crack-spread positions. Crack-spread hedgers ignore nearby high-season price risk at their peril, but they would also be remiss to ignore the long horizon.

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