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Welfare Gains from Market Insurance: The Case of Mexican Oil Price Risk

Chang Ma and Fabian Valencia ()

No 2018/035, IMF Working Papers from International Monetary Fund

Abstract: Over the past two decades, Mexico has hedged oil price risk through the purchase of put options. We examine the resulting welfare gains using a standard sovereign default model calibrated to Mexican data. We show that hedging increases welfare by reducing income volatility and reducing risk spreads on sovereign debt. We find welfare gains equivalent to a permanent increase in consumption of 0.44 percent with 90 percent of these gains stemming from lower risk spreads.

Keywords: WP; strike price; present discounted value; Hedging; Commodity exporters; Sovereign debt; Default; welfare gain; hedging economy; cost premium; bond price; hedging program; default incentive; hedging increases social welfare; commodity-price swing; Oil prices; Personal income; Options; Asset prices; Global; oil price risk; B welfare; oil price process; averse investor; Income (search for similar items in EconPapers)
Pages: 39
Date: 2018-03-02
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Handle: RePEc:imf:imfwpa:2018/035