Downside Risk and the Energy Hedger’s Horizon

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Title: Downside Risk and the Energy Hedger’s Horizon
Authors: Conlon, Thomas
Cotter, John
Permanent link: http://hdl.handle.net/10197/3868
Date: Aug-2012
Abstract: 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.
Funding Details: Science Foundation Ireland
Type of material: Working Paper
Publisher: University College Dublin Geary Institute
Copyright (published version): 2012, UCD Geary Institute
Keywords: Downside risk;Hedging horizon;Futures hedging;Energy hedging;Wavelet transform
Subject LCSH: Hedging (Finance)
Financial risk management
Wavelets (Mathematics)
Language: en
Status of Item: Not peer reviewed
Appears in Collections:FMC² Research Collection
Business Research Collection

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