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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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  1. John Cotter & Jim Hanly, 2011. "Re-evaluating Hedging Performance," Working Papers 200518, Geary Institute, University College Dublin.
  2. 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.
  3. Chris Brooks & Alešs Černý & Joëlle Miffre, 2012. "Optimal hedging with higher moments," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 32(10), pages 909-944, October.
  4. Eric Ghysels & Pedro Santa-Clara & Rossen Valkanov, 2004. "There is a Risk-Return Tradeoff After All," CIRANO Working Papers 2004s-24, CIRANO.
  5. 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.
  6. 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.
  7. Demirer, Riza & Lien, Donald, 2003. "Downside risk for short and long hedgers," International Review of Economics & Finance, Elsevier, vol. 12(1), pages 25-44.
  8. Hui Guo & Robert Whitelaw, 2005. "Uncovering the risk-return relation in the stock market," Working Papers 2001-001, Federal Reserve Bank of St. Louis.
  9. R. Mehra & E. Prescott, 2010. "The equity premium: a puzzle," Levine's Working Paper Archive 1401, David K. Levine.
  10. Cotter, John & Hanly, Jim, 2012. "A utility based approach to energy hedging," Energy Economics, Elsevier, vol. 34(3), pages 817-827.
  11. Joseph Eisenhauer & Luigi Ventura, 2003. "Survey measures of risk aversion and prudence," Applied Economics, Taylor & Francis Journals, vol. 35(13), pages 1477-1484.
  12. Sadorsky, Perry, 2002. "Time-varying risk premiums in petroleum futures prices," Energy Economics, Elsevier, vol. 24(6), pages 539-556, November.
  13. 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.
  14. 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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