Estimation Of Optimal Hedge Ratio For Oil Futures An Application To The Ethiopian Petroleum Supply Enterprise

Ethiopian Petroleum Supply Enterprise, the sole importer of different oil products in Ethiopia is exposed to price fluctuation risk. Hedging oil with futures contract can offset this risk. So, the most important issue is to what extent or percentage the risk exposure should be hedged with futures contract. The aim of this thesis is to estimate an optimal hedge ratio that will provide the highest price risk reduction using monthly spot and futures price from October, 1990 to March ,2019. Hedge ratios and hedging effectiveness are determined by employing three models namely: Naïve, OLS (Ordinary Least Square) and ECM (Error Correction Model). Hedging effectiveness is evaluated and compared for the three models. The empirical results show that the ECM model provide highest variance(risk) reduction as compared to other models indicating that this model fits better in designing hedging strategy for EPSE. The empirical finding suggests that the EPSE can use oil futures contract as an effective instrument to minimize price fluctuation risk.

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