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Hedging price risk when payment dates are uncertain

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  • Korn, Olaf
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    Abstract

    This paper studies the hedging of price risk when payment dates are uncertain, a problem that frequently occurs in practice. It derives and establishes the variance minimizing dynamic hedging strategy, using forward contracts with different times to maturity. The resulting strategy fully hedges the expected price exposure for each possible payment date and is, therefore, easy to implement. An empirical study compares the performance of the variance minimizing strategy with heuristic alternatives, based on data from the crude oil market and the foreign exchange market. Our analysis shows that the variance minimizing strategy clearly outperforms the alternatives for the crude oil market. For the foreign exchange market, a simple static hedging strategy is sufficient. --

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    Bibliographic Info

    Paper provided by University of Cologne, Centre for Financial Research (CFR) in its series CFR Working Papers with number 07-14.

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    Date of creation: 2009
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    Handle: RePEc:zbw:cfrwps:0714

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    Keywords: risk management; hedging; forwards; uncertainty of time;

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    1. Christopher L. Culp & Merton H. Miller, 1995. "Metallgesellschaft And The Economics Of Synthetic Storage," Journal of Applied Corporate Finance, Morgan Stanley, Morgan Stanley, vol. 7(4), pages 62-76.
    2. Richard Roll & Shu Yan, 2000. "An explanation of the forward premium 'puzzle'," European Financial Management, European Financial Management Association, European Financial Management Association, vol. 6(2), pages 121-148.
    3. Rolfo, Jacques, 1980. "Optimal Hedging under Price and Quantity Uncertainty: The Case of a Cocoa Producer," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 88(1), pages 100-116, February.
    4. Suleyman Basak & Georgy Chabakauri, 2010. "Dynamic Mean-Variance Asset Allocation," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 23(8), pages 2970-3016, August.
    5. Adam, Tim R. & Fernando, Chitru S., 2006. "Hedging, speculation, and shareholder value," Journal of Financial Economics, Elsevier, Elsevier, vol. 81(2), pages 283-309, August.
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    8. Anderson, Ronald W & Danthine, Jean-Pierre, 1980. " Hedging and Joint Production: Theory and Illustrations," Journal of Finance, American Finance Association, American Finance Association, vol. 35(2), pages 487-98, May.
    9. Jaime Casassus & Pierre Collin-Dufresne, 2005. "Stochastic Convenience Yield Implied from Commodity Futures and Interest Rates," Journal of Finance, American Finance Association, American Finance Association, vol. 60(5), pages 2283-2331, October.
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    11. Loderer, Claudio & Pichler, Karl, 2000. "Firms, do you know your currency risk exposure? Survey results," Journal of Empirical Finance, Elsevier, Elsevier, vol. 7(3-4), pages 317-344, November.
    12. Gregory W. Brown & Peter R. Crabb & David Haushalter, 2006. "Are Firms Successful at Selective Hedging?," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 79(6), pages 2925-2950, November.
    13. Eduardo Schwartz & James E. Smith, 2000. "Short-Term Variations and Long-Term Dynamics in Commodity Prices," Management Science, INFORMS, INFORMS, vol. 46(7), pages 893-911, July.
    14. Briys, Eric & Crouhy, Michel & Schlesinger, Harris, 1993. "Optimal hedging in a futures market with background noise and basis risk," European Economic Review, Elsevier, Elsevier, vol. 37(5), pages 949-960, June.
    15. Alex Maynard & Peter C. B. Phillips, 2001. "Rethinking an old empirical puzzle: econometric evidence on the forward discount anomaly," Journal of Applied Econometrics, John Wiley & Sons, Ltd., John Wiley & Sons, Ltd., vol. 16(6), pages 671-708.
    16. DeMarzo, Peter M & Duffie, Darrell, 1995. "Corporate Incentives for Hedging and Hedge Accounting," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 8(3), pages 743-71.
    17. Eaker, Mark R. & Grant, Dwight, 1985. "Optimal hedging of uncertain and long-term foreign exchange exposure," Journal of Banking & Finance, Elsevier, Elsevier, vol. 9(2), pages 221-231, June.
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