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Optimal hedge ratio and elasticity of risk aversion

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  • Udo Broll

    ()
    (Department of Economics, Dresden University of Technology)

  • Jack E. Wahl

    ()
    (Department of Finance, University of Dortmund)

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    Abstract

    We apply the mean-standard deviation paradigm to examine a widely used model of the hedging literature. As the hedging model satisfies a scale and location condition the mean-standard deviation technique provides more intuition for the revision of the firm's optimum risk taking when price volatility changes. By introducing risk aversion elasticity we describe the interaction of price risk and optimum hedge. We show that with unit risk aversion elasticity optimum hedge ratio is invariant to changes in price volatilities.

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    File URL: http://www.accessecon.com/pubs/EB/2004/Volume6/EB-03F30006A.pdf
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    Bibliographic Info

    Article provided by AccessEcon in its journal Economics Bulletin.

    Volume (Year): 6 (2004)
    Issue (Month): 5 ()
    Pages: 1-7

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    Handle: RePEc:ebl:ecbull:eb-03f30006

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    Keywords: elasticity of risk aversion;

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    1. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
    2. Fanny Demers & Michel Demers, 1991. "Increases in Risk and the Optimal Deductible," Carleton Economic Papers 91-03, Carleton University, Department of Economics, revised Dec 1991.
    3. Ormiston, Michael B & Schlee, Edward E, 2001. "Mean-Variance Preferences and Investor Behaviour," Economic Journal, Royal Economic Society, vol. 111(474), pages 849-61, October.
    4. Lars Tyge Nielsen & Fatma Lajeri, 2000. "Parametric characterizations of risk aversion and prudence," Economic Theory, Springer, vol. 15(2), pages 469-476.
    5. Wong, Kit Pong, 1996. "Background Risk and the Theory of the Competitive Firm under Uncertainty," Bulletin of Economic Research, Wiley Blackwell, vol. 48(3), pages 241-51, July.
    6. Briys, Eric & Crouhy, Michel & Schlesinger, Harris, 1993. "Optimal hedging in a futures market with background noise and basis risk," European Economic Review, Elsevier, vol. 37(5), pages 949-960, June.
    7. Wagener, Andreas, 2002. "Prudence and risk vulnerability in two-moment decision models," Economics Letters, Elsevier, vol. 74(2), pages 229-235, January.
    8. Kimball, Miles S, 1993. "Standard Risk Aversion," Econometrica, Econometric Society, vol. 61(3), pages 589-611, May.
    9. Bar-Shira, Ziv & Finkelshtain, Israel, 1999. "Two-moments decision models and utility-representable preferences," Journal of Economic Behavior & Organization, Elsevier, vol. 38(2), pages 237-244, February.
    10. Broll, Udo & Wahl, Jack E. & Zilcha, Itzhak, 1995. "Indirect hedging of exchange rate risk," Journal of International Money and Finance, Elsevier, vol. 14(5), pages 667-678, October.
    11. Meyer, Jack, 1987. "Two-moment Decision Models and Expected Utility Maximization," American Economic Review, American Economic Association, vol. 77(3), pages 421-30, June.
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