Risk Return Trade-offs from Hedging Oil Price Risk in Ecuador

Abstract

This paper analyses methods to reduce the price risk of Ecuadorian oil exports through hedging in the oil futures market. I simulate ex ante cross hedges over the 1991–96 period and find that in every case, ex ante hedging would have been effective in reducing risk. I provide quantitative estimates of the return/risk trade-offs from hedging Ecuadorian oil and find that for risk minimising short hedges, a 1 per cent reduction in risk would have cost a reduction in return of 0.65 per cent. In sum, I find that oil futures hedging offers Ecuador significant risk-reduction potential.