Downside Risk and the Energy Hedger’s Horizon

In this paper, we explore the impact of investor time-horizon on an optimal downside hedged energy portfolio.
Previous studies have shown that minimum-variance hedging effectiveness improves for longer horizons using
variance as the performance metric. This paper investigates whether this result holds for different hedging objectives
and effectiveness measures. A wavelet transform is applied to calculate the optimal heating oil hedge ratio
using a variety of downside objective functions at different time-horizons. We demonstrate decreased hedging
effectiveness for increased levels of uncertainty at higher confidence intervals. Moreover, for each of the different
hedging objectives and effectiveness measures studied, we also demonstrate increasing hedging effectiveness at
longer horizons. While small differences in effectiveness are found across the different hedging objectives, time horizon
effects are found to dominate confirming the importance of considering the hedgers horizon. The findings
suggest that while downside risk measures are useful in the computation of an optimal hedge ratio that accounts
for unwanted negative returns, hedging horizon and confidence intervals should also be given careful consideration
by the energy hedger.