Hedging mean-reverting commodities

Hedging mean-reverting commodities

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Article ID: iaor200973365
Volume: 21
Issue: 1
Start Page Number: 19
End Page Number: 26
Publication Date: Jan 2010
Journal: IMA Journal of Management Mathematics
Authors: , ,
Keywords: hedging
Abstract:

This paper uses the expected utility framework to examine the optimal hedging decision for commodities with mean-reverting price processes. The derived results show that when commodity prices follow a mean-reverting process, the optimal hedge ratio differs significantly from the classical results found under standard geometric Brownian motion. Hence, a failure to accommodate mean reversion when it exists can lead to systematic biases in hedging decisions.

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