Articlegreen1996

RELAXING THE ASSUMPTIONS OF MINIMUM-VARIANCE HEDGING

79 citations0/0 files storedRePEc: Research Papers in Economics

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Risk Management in Financial Firms Stochastic processes and financial applications Financial Risk and Volatility Modeling

Abstract

The most important minimum-variance hedging ration assumptions are (a) that production is deterministic and (b) that all of the agent's wealth is invested in the cash position. Stochastic production greatly reduces optimal hedge ratios. An alternative investment greatly reduces opportunity costs of not hedging by "diluting" the cash position. Stochastic production and/or alternative investments render the costs associated with hedging relatively more important, yielding almost negligible net benefits of hedging. Hence, hedging costs typically dismiss in hedging models for being seemingly negligible are important determinants of hedging behavior.

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References

1979The Hedging Performance of the New Futures Markets 1979Approximating Expected Utility by a Function of Mean and Variance 1991Bivariate garch estimation of the optimal commodity futures Hedge 1984Mean-Variance Versus Direct Utility Maximization 1971A Linear Alternative to Quadratic and Semivariance Programming for Farm Planning under Uncertainty 1989Generalized Optimal Hedge Ratio Estimation 1981A General Mean-Variance Approximation to Expected Utility for Short Holding Periods 1983Optimal hedging in the futures market under price uncertainty

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