Optimal Hedging with Higher Moments
AbstractThis study proposes a utility-based framework for the determination of optimal hedge ratios that can allow for the impact of higher moments on the hedging decision. The approach is applied to a set of 20 commodities that are hedged with futures contracts. We find that in sample, the performance of hedges constructed allowing for non-zero higher moments is only very slightly better than the performance of the much simpler OLS hedge ratio. When implemented out of sample, utility-based hedge ratios are usually less stable over time, and can make investors worse off for some assets compared to hedging using the traditional methods. We conclude, in common with a growing body of very recent literature, by suggesting that higher moments matter in theory but not in practice.
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Bibliographic InfoPaper provided by Henley Business School, Reading University in its series ICMA Centre Discussion Papers in Finance with number icma-dp2006-12.
Length: 33 pages
Date of creation: Nov 2006
Date of revision:
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Utility-based hedging; OLS; Non-normality; risk; commodity futures; skewness; kurtosis;
Other versions of this item:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
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- Stutzer, Michael, 2013. "Optimal hedging via large deviation," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 392(15), pages 3177-3182.
- John Cotter & Jim Hanly, 2014. "Performance of Utility Based Hedges," Working Papers 201404, Geary Institute, University College Dublin.
- 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.
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