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Performance of Utility Based Hedges

  • John Cotter

    (UCD School of Business, University College Dublin)

  • Jim Hanly

    (UCD School of Business, University College Dublin)

Hedgers as investors are concerned with both risk and return; however the literature has generally neglected the role of both returns and investor risk aversion by its focus on minimum variance hedging. In this paper we address this by using utility based performance metrics to evaluate the hedging effectiveness of utility based hedges for hedgers with both moderate and high risk aversion together with the more traditional minimum variance approach. We apply our approach to two asset classes, equity and energy, for three different hedging horizons, daily,weekly and monthly. We find significant differences between the minimum variance and utility based hedges and their attendant performance in-sample for all frequencies. However out of sample performance differences persist for the monthly frequency only.

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File URL: http://www.ucd.ie/geary/static/publications/workingpapers/gearywp201404.pdf
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Paper provided by Geary Institute, University College Dublin in its series Working Papers with number 201404.

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Length: 24 pages
Date of creation: 19 Feb 2014
Date of revision:
Handle: RePEc:ucd:wpaper:201404
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  2. John Cotter & Jim Hanly, 2011. "Time Varying Risk Aversion: An Application to Energy Hedging," Papers 1103.5968, arXiv.org.
  3. Cotter, John & Hanly, James, 2005. "Re-evaluating Hedging Performance," MPRA Paper 3523, University Library of Munich, Germany.
  4. Ser-Huang Poon & Clive W.J. Granger, 2003. "Forecasting Volatility in Financial Markets: A Review," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 478-539, June.
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  7. Ted Juhl & Ira G. Kawaller & Paul D. Koch, 2012. "The Effect of the Hedge Horizon on Optimal Hedge Size and Effectiveness When Prices are Cointegrated," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 32(9), pages 837-876, 09.
  8. Donald Lien, 2012. "A note on utility‐based futures hedging performance measure," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 32(1), pages 92-97, 01.
  9. Demirer, Riza & Lien, Donald, 2003. "Downside risk for short and long hedgers," International Review of Economics & Finance, Elsevier, vol. 12(1), pages 25-44.
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  14. Chris Brooks & A.Cerny & J. Miffre, 2006. "Optimal Hedging with Higher Moments," ICMA Centre Discussion Papers in Finance icma-dp2006-12, Henley Business School, Reading University.
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  16. Joseph Eisenhauer & Luigi Ventura, 2003. "Survey measures of risk aversion and prudence," Applied Economics, Taylor & Francis Journals, vol. 35(13), pages 1477-1484.
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  18. Baron, David P, 1977. "On the Utility Theoretic Foundations of Mean-Variance Analysis," Journal of Finance, American Finance Association, vol. 32(5), pages 1683-97, December.
  19. Lien, Donald & Tse, Y K, 2002. " Some Recent Developments in Futures Hedging," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 357-96, July.
  20. Chia-Lin Chang & Michael McAleer & Roengchai Tansuchat, 2010. "Crude Oil Hedging Strategies Using Dynamic Multivariate GARCH," KIER Working Papers 743, Kyoto University, Institute of Economic Research.
  21. Joëlle Miffre, 2004. "Conditional OLS minimum variance hedge ratios," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 24(10), pages 945-964, October.
  22. Efimova, Olga & Serletis, Apostolos, 2014. "Energy markets volatility modelling using GARCH," Energy Economics, Elsevier, vol. 43(C), pages 264-273.
  23. Ederington, Louis H, 1979. "The Hedging Performance of the New Futures Markets," Journal of Finance, American Finance Association, vol. 34(1), pages 157-70, March.
  24. Cédric de Ville de Goyet & Geert Dhaene & Piet Sercu, 2008. "Testing the martingale hypothesis for futures prices: Implications for hedgers," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 28(11), pages 1040-1065, November.
  25. Ronald D. Ripple & Imad A. Moosa, 2007. "Hedging effectiveness and futures contract maturity: the case of NYMEX crude oil futures," Applied Financial Economics, Taylor & Francis Journals, vol. 17(9), pages 683-689.
  26. Pan, Zhiyuan & Wang, Yudong & Yang, Li, 2014. "Hedging crude oil using refined product: A regime switching asymmetric DCC approach," Energy Economics, Elsevier, vol. 46(C), pages 472-484.
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