Time Varying Risk Aversion: An Application to Energy Hedging
John Cotter () and
Jim Hanly ()
No 201007, Working Papers from Geary Institute, University College Dublin
Risk aversion is a key element of utility maximizing hedge strategies; however, it has typically been assigned an arbitrary value in the literature. This paper instead applies a GARCH-in-Mean (GARCH-M) model to estimate a time-varying measure of risk aversion that is based on the observed risk preferences of energy hedging market participants. The resulting estimates are applied to derive explicit risk aversion based optimal hedge strategies for both short and long hedgers. Out-of-sample results are also presented based on a unique approach that allows us to forecast risk aversion, thereby estimating hedge strategies that address the potential future needs of energy hedgers. We find that the risk aversion based hedges differ significantly from simpler OLS hedges. When implemented in-sample, risk aversion hedges for short hedgers outperform the OLS hedge ratio in a utility based comparison.
Keywords: Energy; Hedging; Risk Management; Risk Aversion; Forecasting (search for similar items in EconPapers)
JEL-codes: G10 G12 G15 (search for similar items in EconPapers)
Pages: 45 pages
New Economics Papers: this item is included in nep-ene, nep-rmg and nep-upt
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http://www.ucd.ie/geary/static/publications/workingpapers/gearywp201007.pdf First version, 2010 (application/pdf)
Working Paper: Time Varying Risk Aversion: An Application to Energy Hedging (2011)
Journal Article: Time-varying risk aversion: An application to energy hedging (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:ucd:wpaper:201007
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