The demand for hedging of oil producers: A tale of risk and regret

Samuel Ouzan and Pierre Six

European Journal of Operational Research, 2025, vol. 321, issue 1, 330-343

Abstract: Rationalizing the relatively low levels of hedging observed in the oil market, compared to those predicted by pure risk minimization, has proven difficult. This article examines whether the objectives of oil producers can explain this discrepancy. From a theoretical perspective, it appears that the observed level of hedging is well explained by risk averse producers who also exhibit regret aversion towards potential losses in the derivatives market. When applying our models to the data, we find that regret effectively rationalizes producers' under-hedging and its persistence. Our results suggest that neither ambiguity surrounding basis risk, nor prospect theory can account for this behavior. Lastly, our findings indicate that relaxing the assumption of market completeness and considering quantity risk also fail to match the observed hedging activity of oil producers.

Keywords: Regret aversion; Under-hedging; Oil market; Speculation; Ambiguity aversion; Prospect theory (search for similar items in EconPapers)
JEL-codes: G11 G12 G14 G41 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:321:y:2025:i:1:p:330-343

DOI: 10.1016/j.ejor.2024.09.036

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