Optimal Hedging With Higher Moments

Chris Brooks, Aleš Cerný, Joëlle Miffre: This study proposes a utility-based framework for the determination of optimal hedge ratios that can allow for the impact of higher moments on hedging decisions.

Author(s):

Chris Brooks

Professor of Finance, ICMA Centre

Ales Cerny

Professor of Finance, Cass Business School

Joelle Miffre

Professor of Finance, EDHEC Business School

We examine the entire hyperbolic absolute risk aversion (HARA) family of utilities which include quadratic, logarithmic, power and exponential utility functions. We find that for both moderate and large spot (commodity) exposures, the performance of out-of-sample hedges constructed allowing for non-zero higher moments is better than the performance of the simpler OLS hedge ratio. The picture is, however, not uniform throughout our seven spot commodities as there is one instance (cotton) for which the modelling of higher moments decreases welfare out-of-sample relative to the simpler OLS. We support our empirical findings by a theoretical analysis of optimal hedging decisions and we uncover a novel link between optimal hedge ratios and the minimax hedge ratio, that is the ratio which minimises the largest loss of the hedged position.
Pdf
Optimal Hedging With Higher Moments...
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Type: Working paper
Date: le 08/04/2013
Extra information : For more information, please contact EDHEC Research and Development Department [ research@drd.edhec.edu ]
Research Cluster : Finance

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