Time-varying risk aversion : an application to energy hedging

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Title: Time-varying risk aversion : an application to energy hedging
Authors: Cotter, John
Hanly, Jim
Permanent link: http://hdl.handle.net/10197/1720
Date: Mar-2010
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.
Type of material: Journal Article
Publisher: Elsevier
Copyright (published version): 2009 Elsevier B.V.
Keywords: Energy Forecasting;Hedging;Risk Management;Risk Aversion;Forecasting
Subject LCSH: Hedging (Finance)
Risk management
Energy industries
DOI: 10.1016/ j.eneco.2009.08.009
Language: en
Status of Item: Peer reviewed
Appears in Collections:Business Research Collection

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