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Risk Aversion, Uncertainty Aversion, And Variation Aversion In Applied Commodity Price Analysis

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  • Frechette, Darren L.
  • Wen, Fang-I
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    Abstract

    Standard models of hedging behavior assume that either hedgers wish to minimize net price variation or they wish to balance variation versus profits. These models treat variation as risk and fail to distinguish between variation that is random and variation that is not random over time. Newer models of decision making differentiate between random and nonrandom variation somewhat, but they inadequately distinguish variation from risk. This paper reviews the distinctions among variation, uncertainty, and risk and calculates optimal hedge ratios for two models addressing the distinction. Empirical optimal hedge ratios typically decline toward zero when variation aversion is included in the models. These results may help explain why hedgers commonly hedge less than recommended by the standard models.

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    File URL: http://purl.umn.edu/19062
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    Bibliographic Info

    Paper provided by NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management in its series 2002 Conference, April 22-23, 2002, St. Louis, Missouri with number 19062.

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    Date of creation: 2002
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    Handle: RePEc:ags:ncrtwo:19062

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    Web page: http://www.agebb.missouri.edu/ncrext/ncr134/

    Related research

    Keywords: Demand and Price Analysis; Marketing;

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    1. John Y. CAMPBELL & Luis VICEIRA, 1998. "Who Should Buy Long-Term Bonds?," FAME Research Paper Series rp5, International Center for Financial Asset Management and Engineering.
    2. Moschini, GianCarlo & Hennessy, David A., 2001. "Uncertainty, Risk Aversion, and Risk Management for Agricultural Producers," Staff General Research Papers 5323, Iowa State University, Department of Economics.
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    5. Weil, Philippe, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 29-42, February.
    6. Lence, Sergio H., 2000. "Using Consumption and Asset Return Data to Estimate Farmersï¾’ Time Preferences and Risk Attitudes," Staff General Research Papers 1930, Iowa State University, Department of Economics.
    7. Kreps, David M & Porteus, Evan L, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Econometrica, Econometric Society, vol. 46(1), pages 185-200, January.
    8. Keith C. Knapp & Lars J. Olson, 1996. "Dynamic Resource Management: Intertemporal Substitution and Risk Aversion," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 78(4), pages 1004-1014.
    9. Darren L. Frechette, 2000. "The Demand for Hedging and the Value of Hedging Opportunities," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 82(4), pages 897-907.
    10. Peter J. Barry & Lindon J. Robison & Gilbert V. Nartea, 1996. "Changing Time Attitudes in Intertemporal Analysis," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 78(4), pages 972-981.
    11. Sergio H. Lence, 2000. "Using Consumption and Asset Return Data to Estimate Farmers' Time Preferences and Risk Attitudes," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 82(4), pages 934-947.
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