Optimal hedging in the US natural gas market: The effect of maturity and cointegration

Abstract

We use the US natural gas market as the rich experimental context to test multiple features of hedging performances. First, we compare the hedging effectiveness of a single futures contract (i.e. Henry Hub) used for hedging six different physical price positions. Second, we examine the performance of hedging, when one uses a futures contract with time-to-maturity beyond the hedging horizon (i.e. a non-matching hedging strategy). Finally, we quantify the effect of accounting for cointegration and also the time varying volatility in the calculation of optimal hedge ratios. As a robustness check we conduct our analysis using both ex-ante (out of sample) and ex-post (in sample) methods. Our findings suggest that using longer maturity contracts may improve the hedging effectiveness. We also find that accounting for cointegration and time varying prices has minimal effect on the hedge ratio and hedging effectiveness for almost all physical prices. Our findings can inform businesses exposed to commodity price risks in on making better risk-management decisions.