Risk aversion, disappointment aversion, and futures hedging
Donald Lien and
Journal of Futures Markets, 2002, vol. 22, issue 2, 123-141
This article examines the effect of disappointment aversion on futures hedging. We incorporated a constant‐absolute‐risk‐aversion (CARA) utility function into the disappointment‐aversion framework of Gul (1991). It is shown that a more disappointment‐averse hedger will choose an optimal futures position closer to the minimum‐variance hedge than will a less‐disappointment‐averse hedger. The effect of disappointment aversion is stronger when the hedger is less risk averse. A small disappointment aversion will cause a near‐risk neutral hedger to take a drastically different position. In addition, a more‐risk‐averse or disappointment‐averse hedger will have a lower reference point. Numerical results indicate that the reference point of a disappointment‐averse hedger tends to be lower than that of a conventional loss‐averse hedger. Consequently, the disappointment‐averse hedger will act more conservatively, not exploiting profitable opportunities as much as the conventional loss averse hedger will. © 2002 John Wiley & Sons, Inc. Jrl Fut Mark 22:123–141, 2002
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