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Hedging Long-Term Forwards with Short-Term Futures: A Two-Regime Approach

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  • Wolfgang Bühler
  • Olaf Korn
  • Rainer Schöbel

Abstract

In this paper we investigate Metallgesellschaft’s problem of hedging long-term forwards with short-term futures. Very different hedging strategies have been proposed in the literature. We attribute these differences to the underlying valuation approaches for oil futures and empirically compare five model-based hedging strategies. In particular, we consider a strategy which results from a two-regime pricing model. This continuous-time equilibrium model reflects the observation that prices of oil futures exhibit a very different behavior for low and high oil prices. Our empirical study shows that time diversification is the dominant effect for an effective hedging of long-term oil forwards with short-term futures. Copyright Kluwer Academic Publishers 2005

Suggested Citation

  • Wolfgang Bühler & Olaf Korn & Rainer Schöbel, 2005. "Hedging Long-Term Forwards with Short-Term Futures: A Two-Regime Approach," Review of Derivatives Research, Springer, vol. 7(3), pages 185-212, October.
    • Handle: RePEc:kap:revdev:v:7:y:2005:i:3:p:185-212
    DOI: 10.1007/s11147-004-4809-1
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