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/10197/2168
Date: 2009
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.
Funding Details: Science Foundation Ireland
Type of material: Conference Publication
Keywords: EnergyHedgingRisk managementRisk aversionForecasting
Subject LCSH: Hedging (Finance)
Risk management
Energy industries
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Language: en
Status of Item: Not peer reviewed
Conference Details: Annual meeting of the Financial Management Association International, October 21-24 2009, Reno, Nevada
Appears in Collections:FMC² Research Collection
Business Research Collection

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