Cross Hedging Under Multiplicative Basis Risk

Adam-Müller, Axel F. A.; Nolte, Ingmar

doi:10.2139/ssrn.1799402

Cited by 10 publications

(4 citation statements)

References 47 publications

(32 reference statements)

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“…Coffee (traded on NYBOT), cotton (NYMEX), corn (CBOT) and crude oil (NYMEX) prices from January 1986 through December 2010, a total of 300 months, were obtained from Datastream. In the context of futures hedging, monthly data has been explored previously in a number of studies due to a reduction in nonsynchroneity problems between futures and cash (Adam-Müller & Nolte, 2011;Ederington & Salas, 2008). Monthly data is appropriate in this study, as it allows contrast to studies of corporate finance hedging policy where the reported data ranges from monthly horizon up to five years (Jin & Jorion, 2006;Allayannis & Ofek, 2001;Haushalter, 17 Confidence intervals for the wavelet variance and covariance may be calculated using large sample theory.…”

Section: Data and Descriptive Statisticsmentioning

confidence: 99%

Commodity futures hedging, risk aversion and the hedging horizon

Conlon

Cotter

Gençay

2015

The European Journal of Finance

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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.

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Section: Data and Descriptive Statisticsmentioning

confidence: 99%

Commodity futures hedging, risk aversion and the hedging horizon

Conlon

Cotter

Gençay

2015

The European Journal of Finance

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“…Franke et al [23] proposed conditions for multiplicative risk vulnerability. Furthermore, Franke et al [24] studied the simultaneous effect of both additive and multiplicative risks and explained some paradoxical choice behavior. In the field of hedging, Adam-Müller and Nolte [25] proposed a model with multiplicative background risk.…”

Section: Introductionmentioning

confidence: 99%

Optimal Hedging with Options and Futures against Price Risk and Background Risk

Sun

2017

MCA

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On the condition that both futures and options exist in the markets for hedging, this paper examines the optimal hedging strategy under price risk and background risk. Compared with the previous research, which has studied options hedging against basis risk and production risk being extended to options and futures hedging against price risk and background risk, we proposed a model and have taken the budget of buying options into consideration. The model is fairly general and some existing models are special cases of it. We firstly derive the necessary and sufficient conditions that guarantee the optimality of an under-hedge, a full-hedge and an over-hedge of futures for the risk-averse utility. Then, sufficient conditions are stipulated under which an over-hedge is optimal. Furthermore, we propose a program minimizing of tail conditional expectation (TCE), which is inherently equivalent to the risk measure of expected shortfall risk (ES) or the conditional VaR (CVaR) under the continuous-time framework. Finally, we find that ES, in our proposed model, is significantly smaller than the one in the model of options hedging only. Therefore, the results emphasize the need for combining futures hedging and options hedging, and it also shows that imposing background risk, whether it be additive or multiplicative, always has a great impact on the hedging efficiency. We also present some sensitivities of the relevant parameters to provide some suggestions for the investors.

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“…On the other hand, we introduce multiplicative background risk to affect both the spot and futures prices in a symmetric manner, which is more suitable to model credit risk or inflation risk. Because of the asymmetric treatment of the multiplicative background risk on the firm's payoff function, Adam-Müller and Nolte (2011) show that prudence in the sense of Kimball (1990Kimball ( , 1993 is called for to yield unambiguous futures positions.…”

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confidence: 99%

Hedging and the competitive firm under correlated price and background risk

Wong

2012

Decisions Econ Finan

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This paper examines the behavior of the competitive firm under correlated price and background risk when a futures market exists for hedging purposes. We show that imposing the background risk, be it additive or multiplicative, on the firm has no effect on the separation theorem. The full-hedging theorem, however, holds if the background risk is independent of the price risk. In the general case of the correlated price and background risk, we adopt the concept of expectation dependence to describe the bivariate dependence structure. When the background risk is additive, the firm finds it optimal to opt for an over-hedge or an under-hedge, depending on whether the price risk is positively or negatively expectation dependent on the background risk, respectively. When the background risk is multiplicative, both the concept of expectation dependence and the Arrow-Pratt measure of relative risk aversion are called for to determine the firm's optimal futures position.

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Cross Hedging Under Multiplicative Basis Risk

Cited by 10 publications

References 47 publications

Commodity futures hedging, risk aversion and the hedging horizon

Commodity futures hedging, risk aversion and the hedging horizon

Optimal Hedging with Options and Futures against Price Risk and Background Risk

Hedging and the competitive firm under correlated price and background risk

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