Reduction in hedging risk from adjusting for autocorrelation in the residuals of a price level regression
✍ Scribed by Emmett Elam
- Publisher
- John Wiley and Sons
- Year
- 1991
- Tongue
- English
- Weight
- 1002 KB
- Volume
- 11
- Category
- Article
- ISSN
- 0270-7314
No coin nor oath required. For personal study only.
✦ Synopsis
T price level regression can reduce hedging risk. When a hedging decision is being made, a hedger derives a target price to indicate the price he expects to achieve from hedging. Usually, the target price is developed from a linear (or price level) regression of local cash price on the nearby futures price. If the residuals in the regression are autocorrelated, the estimate of the autocorrelation coefficient from the regression residuals can be used to adjust the target price to obtain a more accurate indicator of the actual (net) price achieved by hedging. In theory, adjusting the target price for autocorrelation reduces hedging risk (defined as variance of net price minus target price).
Price level regressions are used extensively to estimate cross hedge ratios.' Hayenga and DiPietre (1982b) use a price level regression to estimate cross hedge ratios for wholesale pork products hedged in live hog futures. and Hayenga and DePietre (1982a) estimate cross hedge ratios for wholesale beef products hedged in live cattle futures. Price level regression is used to analyze cross hedging of distiller's dried grain (Miller, 1982a), feeder pigs ,