Type

Journal Article

Authors

John Cotter
Jim Hanly

Subjects

Business

Topics
hedging finance finance and financial management energy energy hedging portfolio and security analysis g12 risk aversion forecasting risk management info eu repo classification jel g15 garch m energy industries g15 hedging energy forecasting info eu repo classification jel g10 g10 info eu repo classification jel g12

Time Varying Risk Aversion: An Application to Energy Hedging (2010)

Abstract Risk aversion is a key element of utility maximizing hedge strategies; however, it has typically been assigned an arbitrary value in the literature. This paper instead applies a GARCH-in-Mean (GARCH-M) model to estimate a time-varying measure of risk aversion that is based on the observed risk preferences of energy hedging market participants. The resulting estimates are applied to derive explicit risk aversion based optimal hedge strategies for both short and long hedgers. Out-of-sample results are also presented based on a unique approach that allows us to forecast risk aversion, thereby estimating hedge strategies that address the potential future needs of energy hedgers. We find that the risk aversion based hedges differ significantly from simpler OLS hedges. When implemented in-sample, risk aversion hedges for short hedgers outperform the OLS hedge ratio in a utility based comparison.
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Full list of authors on original publication

John Cotter, Jim Hanly

Experts in our system

1
John Cotter
University College Dublin
Total Publications: 93
 
2
Jim Hanly
University College Dublin
Total Publications: 16