The impact of hedging on risk-averse agents’ output decisions

In this study, we develop a forward-looking hedging factor variant of the output Euler model for an economy featuring uncertainty and risk-averse agents. Our novel approach goes beyond the traditional prospective viewpoint characterized by output growth expectations. Using a hedging factor constructed as the net-long trading measure obtained from quarterly equity futures data, covering the period 1993 to 2020, we identify different channels through which uncertainty about macroeconomic fundamentals affects economic output. The results reveal that the hedging factor influences uncertainty via the market volatility channel. This study provides the first piece of empirical evidence indicating that risk-averse agents place meaningful and significant weight on the hedging factor in economic decisions. The findings, which are robust to various measures of output growth, indicate that the hedging factor is a relevant state variable that influences future output decisions under conditions of macroeconomic uncertainty.