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Business Challenge

  • Our client, a leading oil trading company wanted to develop a robust risk management strategy to account for the high levels of volatility in the crude oil market.
  • Validate existing hypotheses around the relationships between various portfolio indices and its corresponding hedge instruments.

Solution

  • Price forecasting models using time series techniques were developed on both the portfolio indices and hedging instruments.
  • Quantification of portfolio risk based on profiling the historical inventory data for average depletion rates/day by portfolio indices.
  • Non-linear optimization framework that combines the price predictions with the risk quantification to arrive at an optimal hedging strategy that minimized the portfolio risk while maximizing its returns.

Impact

  • Robust hedging strategy that maximizes returns while minimizing portfolio risks.
  • Enabled the client answer quantitatively:
  • What is the amount of risk carried in the portfolio?
  • What instruments should be used for the hedge and in which direction?
  • How much of the portfolio should be hedged for maximum returns?