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Downside risk and the energy hedger's horizon

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  • Thomas Conlon

    (Smurfit School of Business, University College Dublin)

  • John Cotter

    (UCD Smurfit School of Business, University College Dublin)

Abstract

In this paper, we explore the impact of investor time-horizon on an optimal downside hedged energy portfolio. Previous studies have shown that minimum-variance hedging effectiveness improves for longer horizons using variance as the performance metric. This paper investigates whether this result holds for different hedging objectives and effectiveness measures. A wavelet transform is applied to calculate the optimal heating oil hedge ratio using a variety of downside objective functions at different time-horizons. We demonstrate decreased hedging effectiveness for increased levels of uncertainty at higher confidence intervals. Moreover, for each of the different hedging objectives and effectiveness measures studied, we also demonstrate increasing hedging effectiveness at longer horizons. While small differences in effectiveness are found across the different hedging objectives, time-horizon effects are found to dominate confirming the importance of considering the hedgers horizon. The findings suggest that while downside risk measures are useful in the computation of an optimal hedge ratio that accounts for unwanted negative returns, hedging horizon and confidence intervals should also be given careful consideration by the energy hedger.

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File URL: http://www.ucd.ie/geary/static/publications/workingpapers/gearywp201219.pdf
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Bibliographic Info

Paper provided by Geary Institute, University College Dublin in its series Working Papers with number 201219.

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Length: 28 pages
Date of creation: 17 Sep 2012
Date of revision:
Handle: RePEc:ucd:wpaper:201219

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Keywords: Energy Hedging; Futures Hedging; Wavelet Transform; Hedging Horizon; Downside Risk;

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  1. António Rua & Luís Catela Nunes, 2009. "International comovement of stock market returns: a wavelet analysis," Working Papers w200904, Banco de Portugal, Economics and Research Department.
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  7. Turvey, Calum G. & Nayak, Govindaray, 2003. "The Semivariance-Minimizing Hedge Ratio," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 28(01), April.
  8. Thomas Conlon & John Cotter, 2012. "An empirical analysis of dynamic multiscale hedging using wavelet decomposition," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 32(3), pages 272-299, 03.
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  16. Babak Eftekhari, 1998. "Lower partial moment hedge ratios," Applied Financial Economics, Taylor & Francis Journals, vol. 8(6), pages 645-652.
  17. Ming-Chih Lee & Jui-Cheng Hung, 2007. "Hedging for multi-period downside risk in the presence of jump dynamics and conditional heteroskedasticity," Applied Economics, Taylor & Francis Journals, vol. 39(18), pages 2403-2412.
  18. David Cabedo, J. & Moya, Ismael, 2003. "Estimating oil price 'Value at Risk' using the historical simulation approach," Energy Economics, Elsevier, vol. 25(3), pages 239-253, May.
  19. Bertsimas, Dimitris & Lauprete, Geoffrey J. & Samarov, Alexander, 2004. "Shortfall as a risk measure: properties, optimization and applications," Journal of Economic Dynamics and Control, Elsevier, vol. 28(7), pages 1353-1381, April.
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