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The Performance of the A0( ) Diffusion Model to Hedge a Forward Commitment in the Corn Market

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  • C. de Ville de Goyet

Abstract

This paper offers an extensive out-of-sample empirical analysis of the problem of hedging a long-term forward exposure in the corn commodity market by trading in short-term commodity futures contracts. A closed-form pricing formula for the forward curve is derived using the canonical A0(N) representation of Dai and Singleton (2000), with N £ 3. The resulting optimal hedge ratio is a function of, among others, the hedging horizon and the maturity of the traded contracts used as hedge instruments, making the method straightforward to apply for longer hedging horizons. The out-of-sample hedging performance of the model strategies for hedging horizons of 10, 50 and 100 weeks are compared, in a meanvariance framework, to the no-hedge and one-to-one hedge strategies. The findings indicate that the A0(N) model strategies are generally better than the no-hedge and the one-toone hedge

Suggested Citation

  • C. de Ville de Goyet, 2008. "The Performance of the A0( ) Diffusion Model to Hedge a Forward Commitment in the Corn Market," Review of Business and Economic Literature, KU Leuven, Faculty of Economics and Business, Review of Business and Economic Literature, vol. 0(4), pages 444-474.
  • Handle: RePEc:ete:revbec:20080404
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    File URL: http://feb.kuleuven.be/rebel/jaargangen/2001-2010/2008/RBE%202008-4/2008-4%20-%20de%20Ville%20de%20Goyet.pdf
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    More about this item

    Keywords

    Hedging; agricultural markets; Kalman filtering; futures pricing;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q14 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Agricultural Finance

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