The Minimum-CVaR strategy with semi-parametric estimation in carbon market hedging problems

Effective hedging strategies are important in reducing price volatility risk for business investors and companies participating into carbon markets. In this paper, we investigate the risk triggered by price fluctuation of European Union Allowance (EUA). A semi-parametric approach with Cornish-Fisher expansion, which approximates the quantile using the higher moments of the distribution, is provided to estimate hedging ratios using CVaR as risk objective function. The approach can successfully capture the features of higher moments with the heavy-tailed and higher kurtosis distribution of the EUA returns which tends to be neglected. The hedging performances of Minimum-CVaR model we proposed and the conventional Minimum-Variance model are evaluated and compared. Our empirical results show that Minimum-CVaR hedging strategy generally outperforms the other in-sample using all the effectiveness criteria while it is not consistent out-of-sample. The proposed semi-parametric Minimum-CVaR strategy with Cornish-Fisher expansion is advisable in carbon market hedging problems.