An Empirical Study On Volatility Spillover And Hedging Between High And Low Sulfur Fuel Futures Markets

On the backdrop of the official implementation of the International Maritime Organization’s(IMO)new sulfur emission regulations,China’s implementation of low sulfur fuel oil export tariff rebates,and the significant fluctuations in global oil prices due to the New Crown Pneumonia epidemic,on June 22,2020,China launched the Shanghai International Energy Exchange,a subsidiary of the Shanghai Futures Exchange internationalized low-sulfur fuel oil futures.Low sulfur fuel oil futures is the fifth internationalized futures contract variety in China and the first one to achieve offshore delivery.It adopts the quotation model of "international platform,net trading,bonded delivery and RMB pricing",which can reflect the supply and demand situation of the global spot market more intuitively,help build a reasonable price mechanism and enhance China’s influence in the global marine fuel oil market.The listing is in line with the development needs of China’s bunker oil supply industry and facilitates hedging by shipping companies and bunker oil suppliers,providing a new risk management tool for enterprises in the bunker oil industry chain.At the same time,as a type of fuel oil,the market price of low sulfur fuel oil futures will inevitably have some impact on the high sulfur fuel oil market.A better understanding of the dynamic characteristics of the price movements of high and low sulfur fuel oil futures is crucial for investors to build a reasonable energy portfolio.Therefore,in this paper,the closing prices of the low sulfur fuel oil index(LU)and fuel oil index(FU)from June 22,2020 to November 9,2022 in the Wind database are selected to represent the futures market prices of low sulfur fuel oil and high sulfur fuel oil,respectively,and their returns,volatility spillover effects and dynamic correlations are analyzed,and the optimal hedging ratio and optimal energy portfolio are calculated on this basis weights.This paper empirically analyzes the mean spillover effect between high and low sulfur fuel oil futures markets using cointegration test,impulse response,Granger test,JJ test and VAR analysis.There is a mean spillover effect between high and low fuel futures markets,and the direction of this spillover effect is bidirectional,i.e.,the returns of both high and low sulfur fuel futures markets are significantly affected by the lagged returns of the other market.Among them,the lag period of high sulfur fuel futures market has a significant negative impact on the yield of low sulfur fuel futures market,and the increase of yield will lead to the decrease of yield of low sulfur fuel futures market;the lag period of low sulfur fuel futures market has a significant positive impact on the yield of high sulfur fuel futures market,and the increase of yield will lead to the increase of yield of high sulfur fuel futures market.It indicates that low-sulfur fuel futures have a price leading role in the energy futures market from the early stage of listing in China.Also,this paper finds that different market states have an impact on the correlation between high and low sulfur fuel futures.During the bull market phase,high and low sulfur fuel futures prices have a cointegrating effect,and there is a causal relationship between low sulfur fuel and high sulfur fuel in the long run;during the adjustment phase,high and low sulfur fuel futures prices do not have a cointegrating effect.To further investigate the volatility spillover between high and low sulfur fuel oil futures markets,four multivariate GARCH models are compared and contrasted to analyze the volatility spillover effect and the dynamic correlation between high and low sulfur fuel oil futures markets,and the optimal hedging ratio and optimal portfolio weights for energy portfolios are calculated and analyzed.The empirical results show that the volatility between high sulfur fuel oil and low sulfur fuel oil varies in both directions,and the multivariate DCC-GARCH model fits the data best;the conditional volatility of the DCC model is used to estimate the dynamic hedging ratios,and it is found that,on average,a $1 long position on high sulfur fuel oil futures,with minimized hedging portfolio variance,can be achieved by establishing a $1 long position in the low sulfur fuel oil futures market by A $1 long position in low sulfur fuel oil futures can be hedged by a $0.79 short position in high sulfur fuel oil futures market.The average weight of the high-sulfur fuel oil/low-sulfur fuel oil portfolio is 0.24,which means that for a $1portfolio,$0.24 should be invested in high-sulfur fuel oil and $0.76 in low-sulfur fuel oil.The significance of this paper is that this study can understand the dynamic relationship between high and low sulfur fuel futures markets,so that policy makers and investors can grasp the direction of risk transfer in the fuel futures market during price fluctuations and enhance their risk identification and decision making ability,and based on the hedging ratio and portfolio weights,investors can better develop hedging strategies and optimize their portfolios to reduce trading risks.Given the relatively short sample period of this study,which may affect the robustness of the conclusions,further research can be conducted in the future when more data on the trading of high and low sulfur fuel futures are available.