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Hedging and risk aversion constraints

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  • Cotter, John
  • Hanly, Jim

Abstract

We examine whether hedging effectiveness is affected by asymmetry in the return distribution by applying tail specific metrics to compare the hedging effectiveness of short and long hedgers using crude oil futures contracts. The metrics used include Lower Partial Moments (LPM), Value at Risk (VaR) and Conditional Value at Risk (CVAR). Comparisons are applied to a number of hedging strategies including OLS and both Symmetric and Asymmetric GARCH models. Our findings show that asymmetry reduces in-sample hedging performance and that there are significant differences in hedging performance between short and long hedgers. Thus, tail specific performance metrics should be applied in evaluating hedging effectiveness. We also find that the Ordinary Least Squares (OLS) model provides consistently good performance across different measures of hedging effectiveness and estimation methods irrespective of the characteristics of the underlying distribution.

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File URL: http://researchrepository.ucd.ie/bitstream/10197/1698/3/cotterj_workpap_pub_018.pdf
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Bibliographic Info

Paper provided by University College Dublin in its series Open Access publications from University College Dublin with number urn:hdl:10197/1698.

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Date of creation: 2005
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Handle: RePEc:ner:ucddub:urn:hdl:10197/1698

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Web page: http://www.ucd.ie

Related research

Keywords: Hedging (Finance)--Evaluation; Risk--Econometric models;

References

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  3. John Cotter & Jim Hanly, 2011. "Re-evaluating Hedging Performance," Working Papers 200518, Geary Institute, University College Dublin.
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  16. Kroner, Kenneth F. & Sultan, Jahangir, 1993. "Time-Varying Distributions and Dynamic Hedging with Foreign Currency Futures," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(04), pages 535-551, December.
  17. Lien, Donald, 2005. "The use and abuse of the hedging effectiveness measure," International Review of Financial Analysis, Elsevier, vol. 14(2), pages 277-282.
  18. Engle, Robert F & Ng, Victor K, 1993. " Measuring and Testing the Impact of News on Volatility," Journal of Finance, American Finance Association, vol. 48(5), pages 1749-78, December.
  19. Conrad, Jennifer & Gultekin, Mustafa N & Kaul, Gautam, 1991. "Asymmetric Predictability of Conditional Variances," Review of Financial Studies, Society for Financial Studies, vol. 4(4), pages 597-622.
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