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| William T. Smith |
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| ''The optimal hedge ratio: A solution, a conjecture, and a challenge'' |
| ( 2022, Vol. 42 No.2 ) |
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| Calculating the Optimal Hedge Ratio (OHR) is challenging for agricultural exporting countries. The alternatives have been either to rely upon closed-form solutions for the OHR that require unpalatable assumptions (quadratic utility, or CARA utility with Gaussian distributions) or to employ complicated numerical methods. This paper derives an approximate closed-form solution for “compact” distributions with “small” risks. Given empirical distributions of prices and quantities it requires simple calculations to arrive at the OHR for any desired class and calibration of risk preferences. To the extent that futures markets are unbiased, the solution also suggests that a simple minimum-variance calculation may be sufficient to calculate the OHR. |
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| Keywords: Optimal Hedge Ratio, Utility Function, Risk Management, Risk Aversion |
JEL: E3 - Prices, Business Fluctuations, and Cycles: General (includes Measurement and Data)
G1 - General Financial Markets |
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| Manuscript Received : Jan 30 2022 | | Manuscript Accepted : Jun 30 2022 |
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