Relaxing the Assumptions of Minimum-Variance Hedging

Sergio Lence

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: The most important minimum-variance hedge-ratio assumptions are (a) that production is deterministic and (b) that all of the agent's wealth is invested in the cash position. Stochastic production greatly reduces optimal hedge ratios. An alternative investment greatly reduces opportunity costs of not hedging by "diluting" the cash position. Stochastic production and/or alternative investments render the costs associated with hedging relatively more important, yielding almost negligible net benefits of hedging. Hence, hedging costs typically dismissed in hedging models for being seemingly negligible are important determinants of hedging behavior.

Date: 1996-01-01
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Related works:
Journal Article: RELAXING THE ASSUMPTIONS OF MINIMUM-VARIANCE HEDGING (1996)
Working Paper: Relaxing the Assumptions of Minimum-Variance Hedging (1996)
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