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Commodity Futures Hedging, Risk Aversion and the Hedging Horizon
Conlon, Thomas; Gençay, Ramazan; Cotter, John
This paper examines the impact of investor preferences on the optimal futures hedging strategy and associated hedging performance. Explicit risk aversion levels are often overlooked in hedging analysis. Applying a mean-variance hedging objective, the optimal futures hedging ratio is determined for a range of investor preferences on risk aversion, hedging horizon and expected returns. Wavelet analysis is applied to illustrate how investor time horizon shapes hedging strategy. Empirical results reveal substantial variation of the optimal hedge ratio for distinct investor preferences and are supportive of the hedging policies of real firms. Hedging performance is then shown to be strongly dependent on underlying preferences. In particular, investors with high levels of risk aversion and a short horizon reduce the risk of the hedge portfolio but achieve inferior utility in comparison to those with low risk aversion. Science Foundation Ireland Names JG 2012-11-16
Keyword(s): Commodity markets; Wavelet analysis; Selective hedging; Risk aversion; Hedging horizon; Futures hedging; Hedging (Finance); Futures; Commodity exchanges; Risk
Publication Date:
2012
Type: Working paper
Peer-Reviewed: Unknown
Language(s): English
Institution: University College Dublin
Publisher(s): UCD Geary Institute
First Indexed: 2012-11-24 05:15:30 Last Updated: 2018-10-11 15:51:45