Risk Aversion, Prudence, and the Three-Moment Decision Model for Hedging

Xiaomei Chen, H. Holly Wang and Ron C. Mittelhammer

No 21485, 2006 Annual meeting, July 23-26, Long Beach, CA from American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association)

Abstract: The linear two-moment mean-variance (MV) model has been widely used in finance and economic decision analysis as an approximation of Von Neumann-Morgenstern expected utility (EU) model. The introduction of third or higher moments not only can improve the accuracy of the approximation, but is also suitable to represent investors¡¯ skewness preference (prudence) with the latter supported by empirical evidence. The goal of this paper is to develop a general MVS model and compare it and the traditional MV model against the EU model in the setting of an individual producer hedging in the futures market. Results show: 1) the derived linear MVS model maintains the analytical convenience of MV model, 2) it can generate different results as MV, 3) it approximate EU better than MV, and 4) it is more flexible than MV.

Keywords: Risk and Uncertainty (search for similar items in EconPapers)
Date: 2006

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Persistent link: http://EconPapers.repec.org/RePEc:ags:aaea06:21485

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