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Article: Production and futures hedging with state-dependent background risk

TitleProduction and futures hedging with state-dependent background risk
Authors
KeywordsFutures
Production
Prudence
State-dependent background risk
Issue Date2012
PublisherElsevier BV. The Journal's web site is located at http://www.elsevier.com/locate/iref
Citation
International Review of Economics & Finance, 2012, v. 24, p. 177-184 How to Cite?
AbstractThis paper examines the production and futures hedging decisions of the competitive firm under output price uncertainty and with state-dependent background risk. We show that the firm's optimal production decision is independent of the underlying uncertainty and of the firm's risk attitude. We further show that the firm's optimal futures position is a full-hedge that completely eliminates the output price risk if either the background risk is state-independent, or the firm's utility function is quadratic. When the firm's preferences exhibit prudence, an under-hedge or an over-hedge is optimal should the magnitude of the background risk vary in a monotonic manner with changes in the realized state. When the prudent firm has access not only to the unbiased futures contracts but also to fairly priced options, we construct a reasonable example wherein the firm optimally includes the options in its hedge position. Hence, we offer a rationale for the hedging role of options, which is over and above that of futures, in the case of state-dependent background risk. © 2012 Elsevier Inc.
Persistent Identifierhttp://hdl.handle.net/10722/146920
ISSN
2015 Impact Factor: 1.846
2015 SCImago Journal Rankings: 0.890
ISI Accession Number ID
References

 

DC FieldValueLanguage
dc.contributor.authorWong, KPen_HK
dc.date.accessioned2012-05-23T05:49:53Z-
dc.date.available2012-05-23T05:49:53Z-
dc.date.issued2012en_HK
dc.identifier.citationInternational Review of Economics & Finance, 2012, v. 24, p. 177-184en_HK
dc.identifier.issn1059-0560en_HK
dc.identifier.urihttp://hdl.handle.net/10722/146920-
dc.description.abstractThis paper examines the production and futures hedging decisions of the competitive firm under output price uncertainty and with state-dependent background risk. We show that the firm's optimal production decision is independent of the underlying uncertainty and of the firm's risk attitude. We further show that the firm's optimal futures position is a full-hedge that completely eliminates the output price risk if either the background risk is state-independent, or the firm's utility function is quadratic. When the firm's preferences exhibit prudence, an under-hedge or an over-hedge is optimal should the magnitude of the background risk vary in a monotonic manner with changes in the realized state. When the prudent firm has access not only to the unbiased futures contracts but also to fairly priced options, we construct a reasonable example wherein the firm optimally includes the options in its hedge position. Hence, we offer a rationale for the hedging role of options, which is over and above that of futures, in the case of state-dependent background risk. © 2012 Elsevier Inc.en_HK
dc.languageengen_US
dc.publisherElsevier BV. The Journal's web site is located at http://www.elsevier.com/locate/irefen_HK
dc.relation.ispartofInternational Review of Economics & Financeen_HK
dc.rightsNOTICE: this is the author’s version of a work that was accepted for publication in International Review of Economics & Finance. Changes resulting from the publishing process, such as peer review, editing, corrections, structural formatting, and other quality control mechanisms may not be reflected in this document. Changes may have been made to this work since it was submitted for publication. A definitive version was subsequently published in International Review of Economics & Finance, 2012, v. 24, p. 177-184. DOI: 10.1016/j.iref.2012.03.002-
dc.rightsCreative Commons: Attribution 3.0 Hong Kong License-
dc.subjectFuturesen_HK
dc.subjectProductionen_HK
dc.subjectPrudenceen_HK
dc.subjectState-dependent background risken_HK
dc.titleProduction and futures hedging with state-dependent background risken_HK
dc.typeArticleen_HK
dc.identifier.emailWong, KP: kpwong@econ.hku.hken_HK
dc.identifier.authorityWong, KP=rp01112en_HK
dc.description.naturepostprint-
dc.identifier.doi10.1016/j.iref.2012.03.002en_HK
dc.identifier.scopuseid_2-s2.0-84859393469en_HK
dc.identifier.hkuros199423en_US
dc.relation.referenceshttp://www.scopus.com/mlt/select.url?eid=2-s2.0-84859393469&selection=ref&src=s&origin=recordpageen_HK
dc.identifier.volume24en_HK
dc.identifier.spage177en_HK
dc.identifier.epage184en_HK
dc.identifier.isiWOS:000306869900015-
dc.publisher.placeNetherlandsen_HK
dc.identifier.scopusauthoridWong, KP=7404759417en_HK
dc.identifier.citeulike10475097-

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