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The Demand for Hedging with Futures and Options

✍ Scribed by Darren L. Frechette

Publisher: John Wiley and Sons
Year: 2001
Tongue: English
Weight: 164 KB
Volume: 21
Category: Article
ISSN: 0270-7314
DOI: 10.1002/fut.1801

No coin nor oath required. For personal study only.

✦ Synopsis

Abstract

The optimal hedging portfolio is shown to include both futures and options under a variety of circumstances when the marginal cost of hedging is nonzero. Futures and options are treated as substitute goods, and the properties of the resulting hedging demand system are explained. The overall optimal hedge ratio is shown to increase when the marginal cost of trading options is reduced. The overall optimal hedge ratio is shown to decrease when the marginal cost of trading futures is decreased. One implication is that hedging demand can be stimulated by a reduction in the perceived cost of trading options through the education of hedgers about options and the initiation of programs such as the Dairy Options Pilot Program. The demand approach is applied to estimate optimal hedge ratios for dairy producers hedging corn inputs in five regions of Pennsylvania. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:693–712, 2001

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