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The Empirical Minimum-Variance Hedge

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  • Sergio H. Lence
  • Dermot J. Hayes

Abstract

Decision making under unknown true parameters (estimation risk) is discussed along with Bayes' and parameter certainty equivalent (PCE) criteria. Bayes' criterion incorporates estimation risk in a manner consistent with expected utility maximization. The PCE method, which is the most commonly used, is not consistent with expected utility maximization. Bayes' criterion is employed to solve for the minimum-variance hedge ratio. Empirical application of Bayes' minimum-variance hedge ratio is addressed and illustrated. Simulations show that discrepancies between prior and sample parameters may lead to substantial differences between Bayesian and PCE minimum-variance hedges.

Suggested Citation

  • Sergio H. Lence & Dermot J. Hayes, 1994. "The Empirical Minimum-Variance Hedge," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 76(1), pages 94-104.
    • Handle: RePEc:oup:ajagec:v:76:y:1994:i:1:p:94-104.
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    File URL: http://hdl.handle.net/10.2307/1243924
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    Cited by:

    1. Shi, Wei & Irwin, Scott H., 2005. "A Bayesian Implementation of the Standard Optimal Hedging Model: Parameter Estimation Risk and Subjective Views," 2005 Annual meeting, July 24-27, Providence, RI 19155, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    2. Pautsch, Gregory R. & Babcock, Bruce A. & Breidt, F. Jay, 1999. "Optimal Information Acquisition Under A Geostatistical Model," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 24(2), pages 1-25, December.
    3. Power, Gabriel J. & Vedenov, Dmitry V., 2008. "The Shape of the Optimal Hedge Ratio: Modeling Joint Spot-Futures Prices using an Empirical Copula-GARCH Model," 2008 Conference, April 21-22, 2008, St. Louis, Missouri 37609, NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    4. repec:dgr:rugsom:96b28 is not listed on IDEAS
    5. David J. Pannell & Getu Hailu & Alfons Weersink & Amanda Burt, 2008. "More reasons why farmers have so little interest in futures markets," Agricultural Economics, International Association of Agricultural Economists, vol. 39(1), pages 41-50, July.
    6. Chen, Ren-Raw & Leistikow, Dean & Wang, Andrew, 2020. "Futures minimum variance hedge ratio determination: An ex-ante analysis," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    7. Muus, L. & Scheer, H. van der & Wansbeek, T., 1996. "A decision theoretic framework for profit maximization in direct marketing," Research Report 96B28, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
    8. Billio, Monica & Casarin, Roberto & Osuntuyi, Anthony, 2018. "Markov switching GARCH models for Bayesian hedging on energy futures markets," Energy Economics, Elsevier, vol. 70(C), pages 545-562.
    9. Pautsch, Gregory R. & Babcock, Bruce A. & Breidt, F. Jay, 1998. "Optimal Sampling Under a Geostatistical Model," Hebrew University of Jerusalem Archive 18424, Hebrew University of Jerusalem.
    10. Ahmad Bash & Abdullah M. Al-Awadhi & Fouad Jamaani, 2016. "Measuring the Hedge Ratio: A GCC Perspective," International Journal of Economics and Finance, Canadian Center of Science and Education, vol. 8(7), pages 1-1, July.
    11. Bessler, Wolfgang & Leonhardt, Alexander & Wolff, Dominik, 2016. "Analyzing hedging strategies for fixed income portfolios: A Bayesian approach for model selection," International Review of Financial Analysis, Elsevier, vol. 46(C), pages 239-256.
    12. Jonathan Dark, 2005. "A Critique of Minimum Variance Hedging," Accounting Research Journal, Emerald Group Publishing, vol. 18(1), pages 40-49, June.
    13. Wilson, William W. & Wagner, Robert & Nganje, William E., 2003. "Strategic Hedging For Grain Processors," Agribusiness & Applied Economics Report 23637, North Dakota State University, Department of Agribusiness and Applied Economics.
    14. Songjiao Chen & William Wilson & Ryan Larsen & Bruce Dahl, 2016. "Risk Management for Grain Processors and “Copulas”," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 64(2), pages 365-382, June.
    15. Dorfman, Jeffrey H. & Sanders, Dwight R., 2004. "Generalized Hedge Ratio Estimation With An Unknown Model," 2004 Conference, April 19-20, 2004, St. Louis, Missouri 19024, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    16. Andreas Röthig, 2009. "Microeconomic Risk Management and Macroeconomic Stability," Lecture Notes in Economics and Mathematical Systems, Springer, number 978-3-642-01565-6, March.
    17. Wei Shi & Scott H. Irwin, 2005. "Optimal Hedging with a Subjective View: An Empirical Bayesian Approach," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 87(4), pages 918-930.
    18. Mason, Charles Edwin, IV, 2000. "Estimation and attenuation of reinsurance risk in the crop insurance market," ISU General Staff Papers 2000010108000013703, Iowa State University, Department of Economics.

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