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Commodity futures hedging, risk aversion and the hedging horizon

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Author Info

  • Thomas Conlon

    (Smurfit School of Business, University College Dublin)

  • John Cotter

    (UCD Smurfit School of Business, University College Dublin)

  • Ramazan Gencay

    (Department of Economics, Simon Fraser University)

Abstract

This paper examines the impact of investor preferences on the optimal futures hedging strategy and associated hedging performance. Explicit risk aversion levels are often overlooked in hedging analysis. Applying a mean-variance hedging objective, the optimal futures hedging ratio is determined for a range of investor preferences on risk aversion, hedging horizon and expected returns. Wavelet analysis is applied to illustrate how investor time horizon shapes hedging strategy. Empirical results reveal substantial variation of the optimal hedge ratio for distinct investor preferences and are supportive of the hedging policies of real firms. Hedging performance is then shown to be strongly dependent on underlying preferences. In particular, investors with high levels of risk aversion and a short horizon reduce the risk of the hedge portfolio but achieve inferior utility in comparison to those with low risk aversion.

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File URL: http://www.ucd.ie/geary/static/publications/workingpapers/gearywp201218.pdf
File Function: First version, 2012
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Bibliographic Info

Paper provided by Geary Institute, University College Dublin in its series Working Papers with number 201218.

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Length: 37 pages
Date of creation: 17 Sep 2012
Date of revision:
Handle: RePEc:ucd:wpaper:201218

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Related research

Keywords: Commodity Markets; Futures Hedging; Risk Aversion; Hedging Horizon; Wavelet Analysis; Selective Hedging;

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References

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