Conclusions

A hedger is a trader who simultaneously holds positions in spot and futures markets in order to reduce spot exposure. However, he does not necessarily minimize the initial spot risk. The minimization of risk is just one single possible outcome from a wide range of potential hedging strategies. Nevertheless, hedging less than the initial spot commitment does not mean that the hedger turns into a speculator. This is because he still holds positions in both markets, with the result that his overall exposure to risk is smaller than if he would only trade in the spot market. Risk is reduced, but not eliminated. The microeconomic part of this thesis focuses on the determinants of firms’ optimal hedging strategies. The impact of price expectations, risk aversion, and hedging costs are particularly important. If hedgers expect spot prices to move in their favor they will be less willing to hedge, since potential returns in the spot market are offset by losses in the futures position. In the presence of hedging costs, the overall profit of the hedged position would be negative if earnings and losses in spot and futures markets were perfectly balanced. Hence, under risk neutrality, companies will not hedge unless there are other incentives to hedge that outweigh the costs. These incentives include taxes, bankruptcy costs and underinvestment problems among others. The models presented in the microeconomic part of this thesis assume a priori that the hedging firm is risk averse.