Crude oil futures to manage the price risk of natural rubber: Empirical evidence from India

Abstract

The trading of natural rubber derivatives in the Indian commodity exchanges was banned several times in the past. Hence, in India, the derivatives on natural rubber are not traded actively and regularly. We have examined the possibility of a forecast model and a cross hedge tool for the natural rubber price by using crude oil futures in India. Results of the Johansen cointegration test proved that there is no cointegration equation in the model; hence, there is no scope to develop long-run models or error correction models. We have developed a vector autoregressive [VAR(2)] model to forecast the rubber price, and we examined the possibility of a cross hedge for natural rubber further by using the Pearson correlation coefficient and Granger causality test. We have extended our research to a structural VAR analysis to examine the effect of crude futures and exchange rate shocks on the natural rubber price. Our results showed that there is a short-term relationship between the crude oil futures price, the exchange rates of the US dollar to the Indian rupee, the Malaysian ringgit to the Indian rupee and the Thai baht to the Indian rupee; and the natural rubber price in India. The effort of policymakers to cause the Indian rupee to appreciate against the Thai baht and Malaysian ringgit may increase the natural rubber price in India. Natural rubber traders, growers and consumers can use crude futures to hedge the price risk. The Indian Rubber Board can suggest the VAR(2) model to predict the short-run price for natural rubber.