Cutting edge: Modelling the correlation function in the crude-oil futures market
Energy market participants often require the computation of coefficients of correlation in a multi-asset portfolio. Addressing crude oil futures contracts, Ehud Ronn proposes and implements a simple procedure to reduce the cross-maturity correlations in crude oil futures to the estimation of two parameters. The paper argues this procedure is more intuitive than traditional principal-components analysis
As applied to the markets for energy commodities, the importance of correlation coefficients is found in the multiplicity of their roles. These roles can be classified as follows:
• Valuation,
• Value-at-risk,
• Risk premium/energy assets as potential financial investments.
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1. Valuation
A number of real and structured products in energy depend on the coefficient of correlation between two or more futures contracts. The value of
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