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Relaxing the Assumptions of Minimum-Variance Hedging

  • Lence, Sergio H.

The most important minimum-variance hedging ration assumptions are (a) that production is deterministic and (b) that all of the agent’'s wealth is invested in the cash position. Stochastic production greatly reduces optimal hedge ratios. An alternative investment greatly reduces opportunity costs of not hedging by “"diluting"” the cash position. Stochastic production and/or alternative investments render the costs associated with hedging relatively more important, yielding almost negligible net benefits of hedging. Hence, hedging costs typically dismiss in hedging models for being seemingly negligible are important determinants of hedging behavior.

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Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 5156.

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Date of creation: 01 Jul 1996
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Publication status: Published in Journal of Agricultural and Resource Economics, July 1996, vol. 21, pp. 39-55
Handle: RePEc:isu:genres:5156
Contact details of provider: Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
Phone: +1 515.294.6741
Fax: +1 515.294.0221
Web page: http://www.econ.iastate.edu
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  1. Kroll, Yoram & Levy, Haim & Markowitz, Harry M, 1984. " Mean-Variance versus Direct Utility Maximization," Journal of Finance, American Finance Association, vol. 39(1), pages 47-61, March.
  2. Lence, Sergio H. & Kimle, Kevin & Hayenga, Marvin L., 1993. "A Dynamic Minimum Variance Hedge," Staff General Research Papers 10833, Iowa State University, Department of Economics.
  3. Tomek, William G., 1987. "Effects of Futures and Options Trading on Farm Incomes," Staff Papers 186718, Cornell University, Department of Applied Economics and Management.
  4. Benninga, Simon & Eldor, Rafael & Zilcha, Itzhak, 1983. "Optimal hedging in the futures market under price uncertainty," Economics Letters, Elsevier, vol. 13(2-3), pages 141-145.
  5. Lence, Sergio H., 1995. "The Economic Value of Minimum-Variance Hedges," Staff General Research Papers 5053, Iowa State University, Department of Economics.
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