Commodity Futures Hedging, Risk Aversion and the Hedging Horizon

This paper examines the impact of investor preferences on the optimal futures hedging strategy
and associated hedging performance. Explicit risk aversion levels are often overlooked
in hedging analysis. Applying a mean-variance hedging objective, the optimal futures hedging
ratio is determined for a range of investor preferences on risk aversion, hedging horizon
and expected returns. Wavelet analysis is applied to illustrate how investor time horizon
shapes hedging strategy. Empirical results reveal substantial variation of the optimal hedge
ratio for distinct investor preferences and are supportive of the hedging policies of real firms.
Hedging performance is then shown to be strongly dependent on underlying preferences. In
particular, investors with high levels of risk aversion and a short horizon reduce the risk of
the hedge portfolio but achieve inferior utility in comparison to those with low risk aversion.