Optimal Hedging and the Partial Loss Offset Provision

Eric Briys and François De Varenne

European Financial Management, 1998, vol. 4, issue 3, 321-333

Abstract: In this paper, we examine how taxation affects the optimal hedging behaviour of an investor exposed to price risk under partial loss offset provision. In this regime, only part of the loss is refunded through the tax. As such, it implies a non‐linearity in the taxation schedule. More specifically, we look at an individual endowed with some fixed quantity of a commodity and facing a price risk. The optimal hedging policy is derived. The comparative statics of a tightening of the PLO provision and a changing risk aversion are analysed. We show that the response of the optimal hedging policy to a change in the tax rate can be signed by a preference free or a preference related sufficient condition, involving the notions of cost‐of‐carry and partial risk aversion.

Date: 1998
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