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/10197/2599
Date: Aug-2009
Online since: 2010-11-25T16:33:17Z
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: Not applicable
Type of material: Working Paper
Publisher: University College Dublin. School of Business. Centre for Financial Markets
University College Dublin. Geary Institute
Series/Report no.: Centre for Financial Markets working paper series; WP 09 08; UCD Geary Institute Discussion Paper Series; WP2010/07
Keywords: EnergyHedgingRisk managementRisk aversionForecasting
Subject LCSH: Hedging (Finance)
Risk management
Energy industries
Other versions: http://www.ucd.ie/bankingfinance/docs/wp/WP-09-08-Cotter-Hanly-hedging-energy.pdf
Language: en
Status of Item: Not peer reviewed
Appears in Collections:Geary Institute Working Papers
Centre for Financial Markets Working Papers

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