Sequential Hedging
Article Abstract:
This paper addresses a problem faced by the producer of a commodity for which futures are traded. The producer wishes to reduce his exposure to the random fluctuations in spot price; however, the futures markets extend out for fewer time periods than the revenue stream that he wants to hedge. The main result of the paper is that under certain conditions on the relationship between the futures prices and past spot price, it is still possible to hedge perfectly; in other words, there exists a sequence of futures positions that entirely eliminates the risk in the present value of the producer's revenues. Under those conditions - which are necessary as well as sufficient - the paper shows explicitly the futures positions that achieve the exact hedge. (Reprinted by Permission of Publisher.)
Publication Name: Management Science
Subject: Business, general
ISSN: 0025-1909
Year: 1985
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Sequential hedging
Article Abstract:
A problem faced by the producer of a commodity for which futures are traded is addressed. The producer wishes to remove the uncertainty in the present value of the revenue stream; however, the futures markets extend out for fewer time periods than the revenue stream the producer wants to hedge. An examination of strategies in which the futures positions are 'rolled forward' with each passing period reveals that one can hedge perfectly if, and only if, the futures prices are linear functions of the spot prices. Because (in practice) the condition that futures prices be linear in the spot prices will never hold exactly, the effectiveness of sequential hedging depends on the extent to which the linearity condition holds.
Publication Name: Management Science
Subject: Business, general
ISSN: 0025-1909
Year: 1985
User Contributions:
Comment about this article or add new information about this topic: