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The effect of liquidity constraints on futures hedging

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  • Donald Lien

Abstract

This article assumes that because of liquidity constraints, a hedge program will be terminated if the cumulative loss from a futures position exceeds a certain threshold. The constraint leads to a smaller futures position. If the hedger has a quadratic utility function, then the optimal futures position is constant regardless of the parameter values and increases as the spot position or the conventional hedge ratio increases. When the capital allocation is small, the hedger tends to ignore this restriction and chooses a larger position. Consequently, the optimal position may decrease as the capital allocation increases. For a moderate capital allocation, the optimal position increases with an increasing capital allocation. Similar properties are established for exponential utility functions. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:603–613, 2003

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  • Donald Lien, 2003. "The effect of liquidity constraints on futures hedging," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 23(6), pages 603-613, June.
    • Handle: RePEc:wly:jfutmk:v:23:y:2003:i:6:p:603-613
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    Cited by:

    1. Shi, Ruoding & Isengildina Massa, Olga, 2018. "Double-Edged Sword: Liquidity Implications of Futures Hedging," 2018 Annual Meeting, August 5-7, Washington, D.C. 274106, Agricultural and Applied Economics Association.
    2. Shi, Ruoding & Isengildina Massa, Olga, 2022. "Costs of Futures Hedging in Corn and Soybean Markets," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 47(2), May.
    3. Olaf Korn & Alexander Merz, 2019. "How to hedge if the payment date is uncertain?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(4), pages 481-498, April.

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