Hedging long-term commodity risk
This study focuses on the problem of hedging longer‐term commodity positions, which often arises when the maturity of actively traded futures contracts on this commodity is limited to a few months. In this case, using a rollover strategy results in a high residual risk, which is related to the uncer...
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Published in | The journal of futures markets Vol. 23; no. 2; pp. 109 - 133 |
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Main Authors | , |
Format | Journal Article |
Language | English |
Published |
New York
Wiley Subscription Services, Inc., A Wiley Company
01.02.2003
Wiley Periodicals Inc |
Subjects | |
Online Access | Get full text |
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Summary: | This study focuses on the problem of hedging longer‐term commodity positions, which often arises when
the maturity of actively traded futures contracts on this commodity is limited to a few months. In this case,
using a rollover strategy results in a high residual risk, which is related to the uncertain futures basis. We use
a one‐factor term structure model of futures convenience yields in order to construct a hedging strategy
that minimizes both spot‐price risk and rollover risk by using futures of two different maturities. The
model is tested using three commodity futures: crude oil, orange juice, and lumber. In the
out‐of‐sample test, the residual variance of the 24‐month combined spot‐futures
positions is reduced by, respectively, 77%, 47%, and 84% compared to the variance of a
naïve hedging portfolio. Even after accounting for the higher trading volume necessary to maintain a
two‐contract hedge portfolio, this risk reduction outweighs the extra trading costs for the investor with
an average risk aversion. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:109–133, 2003 |
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Bibliography: | ark:/67375/WNG-16VSGQMF-Q ArticleID:FUT10060 istex:E9A3EF4AA02CE8B123FABF4F3AF028ED21642015 ObjectType-Article-2 SourceType-Scholarly Journals-1 ObjectType-Feature-1 content type line 23 |
ISSN: | 0270-7314 1096-9934 |
DOI: | 10.1002/fut.10060 |