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Cross hedging under multiplicative basis risk

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Author Info

  • Adam-Müller, Axel F.A.
  • Nolte, Ingmar

Abstract

Cross hedging price risk in an incomplete financial market creates basis risk. We propose a new way of modeling basis risk where price risk and basis risk are combined in a multiplicative way. Under this specification, positive prudence is a necessary and sufficient condition for underhedging in an unbiased market. Using the example of cross hedging jet fuel price risk with crude oil futures, we show that the new specification is superior in describing the price series and that optimal cross hedges differ significantly from those derived under the traditional additive cross hedging model.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 35 (2011)
Issue (Month): 11 (November)
Pages: 2956-2964

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Handle: RePEc:eee:jbfina:v:35:y:2011:i:11:p:2956-2964

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Web page: http://www.elsevier.com/locate/jbf

Related research

Keywords: Risk management Cross hedging Basis risk Prudence Jet fuel Crude oil futures Vector error correction model;

References

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Cited by:
  1. Brian Lucey & Britta Berghöfer, 2013. "Fuel Hedging, Operational Hedging and Risk Exposure– Evidence from the Global Airline Industry," The Institute for International Integration Studies Discussion Paper Series iiisdp433, IIIS.
  2. Thomas Conlon & John Cotter & Ramazan Gencay, 2012. "Commodity futures hedging, risk aversion and the hedging horizon," Working Papers 201218, Geary Institute, University College Dublin.
  3. Marcelo J. Villena & Axel A. Araneda, 2014. "Option Pricing of Twin Assets," Papers 1401.6735, arXiv.org.

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