RISK AVERSION, UNCERTAINTY AVERSION, AND VARIATION AVERSION IN APPLIED COMMODITY PRICE ANALYSIS

Darren L. Frechette and Fang-I Wen

No 19062, 2002 Conference, April 22-23, 2002, St. Louis, Missouri from NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management

Abstract: Standard models of hedging behavior assume that either hedgers wish to minimize net price variation or they wish to balance variation versus profits. These models treat variation as risk and fail to distinguish between variation that is random and variation that is not random over time. Newer models of decision making differentiate between random and nonrandom variation somewhat, but they inadequately distinguish variation from risk. This paper reviews the distinctions among variation, uncertainty, and risk and calculates optimal hedge ratios for two models addressing the distinction. Empirical optimal hedge ratios typically decline toward zero when variation aversion is included in the models. These results may help explain why hedgers commonly hedge less than recommended by the standard models.

Keywords: Demand and Price Analysis; Marketing (search for similar items in EconPapers)
Pages: 18
Date: 2002
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Persistent link: https://EconPapers.repec.org/RePEc:ags:ncrtwo:19062

DOI: 10.22004/ag.econ.19062

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