Costs and Benefits of Using NYMEX Crude Oil Futures

Transferring the risk of price changes, or hedging, is most desirable when the costs of doing so are low relative to the benefits. This paper discusses the nature of these benefits and costs and reports on a related analysis of data from the NYMEX crude oil futures market. It is shown that likely risk reduction is directly related to the degree to which the crude oil futures, market can be characterized as efficient. Using data from the highly volatile period of 1983-90, we find evidence that supports the proposition that the crude oil futures market is efficient. There is no evidence for the existence of risk premiums, which constitute an additional cost to hedging. This is good news for hedgers, as it implies that risk transfer is free in the sense that hedgers need pay no premium to speculators.