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- PublicationTime varying risk aversion : an application to energy hedging(University College Dublin. School of Business. Centre for Financial Markets, 2009-08)Risk aversion is a key element of utility maximizing hedge strategies; however, it has typically been assigned an arbitrary value in the literature. This paper instead applies a GARCH-in-Mean (GARCH-M) model to estimate a time-varying measure of risk aversion that is based on the observed risk preferences of energy hedging market participants. The resulting estimates are applied to derive explicit risk aversion based optimal hedge strategies for both short and long hedgers. Out-of-sample results are also presented based on a unique approach that allows us to forecast risk aversion, thereby estimating hedge strategies that address the potential future needs of energy hedgers. We find that the risk aversion based hedges differ significantly from simpler OLS hedges. When implemented in-sample, risk aversion hedges for short hedgers outperform the OLS hedge ratio in a utility based comparison.
- PublicationOil volatility and the option value of waiting : an analysis of the G-7(University College Dublin. School of Business. Centre for Financial Markets, 2009-08)There has recently been considerable interest in the potential adverse effects associated with excessive uncertainty in energy futures markets. Theoretical models of investment under uncertainty predict that increased uncertainty will tend to induce firms to delay investment. These models are widely utilized in capital budgeting decisions, particularly in the energy sector. There is relatively little empirical evidence, however, on whether such channels have industry-wide effects. Using a sample of G7 countries we examine whether uncertainty about a prominent commodity – oil – affects the time series variation in manufacturing activity. Our primary result is consistent with the predictions of real options theory – uncertainty about oil prices has had a negative and significant effect on manufacturing activity in Canada, France, UK and US.
- PublicationHedging : scaling and the investor horizon(University College Dublin. School of Business. Centre for Financial Markets, 2009-08)This paper examines the volatility and covariance dynamics of cash and futures contracts that underlie the Optimal Hedge Ratio (OHR) across different hedging time horizons. We examine whether hedge ratios calculated over a short term hedging horizon can be scaled and successfully applied to longer term horizons. We also test the equivalence of scaled hedge ratios with those calculated directly from lower frequency data and compare them in terms of hedging effectiveness. Our findings show that the volatility and covariance dynamics may differ considerably depending on the hedging horizon and this gives rise to significant differences between short term and longer term hedges. Despite this, scaling provides good hedging outcomes in terms of risk reduction which are comparable to those based on direct estimation.
- PublicationInvestigating sources of unanticipated exposure in industry stock returns(University College Dublin. School of Business. Centre for Financial Markets, 2009)This paper investigates the degree of both foreign exchange rate and interest rate exposure of industry level portfolios in the G7. Our paper draws on the efficient market hypothesis and examines the extent of unexpected foreign exchange (and interest rate) exposure rather than the standard approach of focusing purely on the change in foreign exchange (and interest rate) exposure. The results from our baseline regressions are consistent with those previously found in the literature that there is little evidence of exchange rate exposure in most markets - this is the exchange rate exposure puzzle. The second critical element of our analysis is that we investigate the sources of the exposure and examine the existence of indirect levels of both foreign exchange and interest rate exposure. The findings of exposure to foreign exchange rates and interest rates are extensive for industry sectors in the G7 economies when we take account of the possible channels of influence. Results indicate key differences between countries in terms of the relative importance of these cash flow and discount rate channels.
- PublicationScaling conditional tail probability and quantile estimators(University College Dublin. School of Business. Centre for Financial Markets, 2009-03)