Pricing and Hedging Illiquid Energy Derivatives: an Application to the JCC Index

Elisa Scarpa, Edison Milano, Italy
Matteo Manera, University of Milano-Bicocca

Abstract

In this paper we discuss a simple strategy for pricing and hedging a swap on the Japanese crude oil cocktail (JCC) index. We compare the empirical performance of different econometric models in terms of their computed OHR, using monthly data on the JCC over the period January 2000-January 2006. We explain how to compute a bid/ask spread and to construct the hedging position for the JCC swap contract with variable oil volume. We evaluate our swap pricing scheme with backtesting and rolling regression techniques. Our empirical findings show that the price-level regression model permits to compute more precise OHR relative to its competing alternatives.