Optimal hedging with higher moments
This study proposes a utility-based framework for the determination of optimal hedge ratios that can allow for the impact of higher moments on the hedging decision. The approach is applied to a set of 20 commodities that are hedged with futures contracts. We find that in sample, the performance of hedges constructed allowing for non-zero higher moments is only very slightly better than the performance of the much simpler OLS hedge ratio. When implemented out of sample, utility-based hedge ratios are usually less stable over time, and can make investors worse off for some assets compared to hedging using the traditional methods. We conclude, in common with a growing body of very recent literature, by suggesting that higher moments matter in theory but not in practice.
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Volume (Year): 32 (2012)
Issue (Month): 10 (October)
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- Vikas Agarwal, 2004. "Risks and Portfolio Decisions Involving Hedge Funds," Review of Financial Studies, Society for Financial Studies, vol. 17(1), pages 63-98.
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- Christie-David, Rohan & Chaudhry, Mukesh, 2001. "Coskewness and cokurtosis in futures markets," Journal of Empirical Finance, Elsevier, vol. 8(1), pages 55-81, March.
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