Risk management in the energy markets and Value-at-Risk modelling: a Hybrid approach

This paper proposes a set of VaR models appropriate to capture the dynamics of energy prices and subsequently quantify energy price risk by calculating VaR and ES measures. Amongst the competing VaR methodologies evaluated in this paper, besides the commonly used benchmark models, a MC simulation approach and a Hybrid MC with Historical Simulation approach, both assuming various processes for the underlying spot prices, are also being employed. All VaR models are empirically tested on eight spot energy commodities that trade futures contracts on NYMEX and the Spot Energy Index. A two-stage evaluation and selection process is applied, combining statistical and economic measures, to choose amongst the competing VaR models. Finally, both long and short trading positions are considered as it is extremely important for energy traders and risk managers to be able to capture efficiently the characteristics of both tails of the distributions.