IDEAS home Printed from
   My bibliography  Save this article

Production and Hedging Under Smooth Ambiguity Preferences


  • Kit Pong Wong


This paper examines the optimal production and hedging decisions of the competitive firm facing ambiguous price and background risk. Ambiguity is modeled by a second‐order probability distribution that captures the firm's uncertainty about which of the subjective beliefs govern the price and background risk. Ambiguity preferences are modeled by the (second‐order) expectation of a concave transformation of the (first‐order) expected utility of profit conditional on each plausible subjective joint distribution of the price and background risk. When the background risk is additive in nature, we show that the separation theorem holds in that the firm's optimal production decision depends neither on the firm's attitude toward ambiguity nor on the incident of the underlying ambiguity. We derive necessary and sufficient conditions under which the firm's optimal forward position is completely characterized. When the background risk is multiplicative in nature, we derive sufficient conditions under which the firm reduces its optimal output level and opts for an under‐hedge. Contrary to the conventional wisdom, we show that the behavior of the firm is affected by the introduction of ambiguity even when the firm is ambiguity neutral. © 2015 Wiley Periodicals, Inc. Jrl Fut Mark 36:506–518, 2016

Suggested Citation

  • Kit Pong Wong, 2016. "Production and Hedging Under Smooth Ambiguity Preferences," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 36(5), pages 506-518, May.
  • Handle: RePEc:wly:jfutmk:v:36:y:2016:i:5:p:506-518

    Download full text from publisher

    File URL:
    Download Restriction: no


    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.

    Cited by:

    1. Simon Quemin, 2016. "Intertemporal abatement decisions under ambiguity aversion in a cap and trade," Working Papers 1604, Chaire Economie du climat.
    2. repec:spr:eurase:v:8:y:2018:i:3:d:10.1007_s40822-018-0096-2 is not listed on IDEAS

    More about this item


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:wly:jfutmk:v:36:y:2016:i:5:p:506-518. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Wiley Content Delivery). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.