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Time varying risk aversion : an application to energy hedging
Author(s)
Date Issued
2009
Date Available
2010-07-15T13:25:10Z
Abstract
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.
Sponsorship
Science Foundation Ireland
Other Sponsorship
University College Dublin. School of Business
Type of Material
Conference Publication
Classification
G10
G12
G15
Subject – LCSH
Hedging (Finance)
Risk management
Energy industries
Language
English
Status of Item
Not peer reviewed
Conference Details
Annual meeting of the Financial Management Association International, October 21-24 2009, Reno, Nevada
This item is made available under a Creative Commons License
File(s)
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Name
Explicit Risk Aversion paper 2009.pdf
Size
721.48 KB
Format
Adobe PDF
Checksum (MD5)
2c119b13c9d6e5efa8bf66794e6cb6c6
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