Premium
Hedging long‐term commodity risk
Author(s) -
VeldMerkoulova Yulia V.,
de Roon Frans A.
Publication year - 2003
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.10060
Subject(s) - futures contract , hedge , rollover (web design) , spot contract , economics , portfolio , econometrics , commodity , financial economics , residual , forward contract , finance , computer science , ecology , algorithm , world wide web , biology
This study focuses on the problem of hedging longer‐term commodity positions, which often arises whenthe maturity of actively traded futures contracts on this commodity is limited to a few months. In this case,using a rollover strategy results in a high residual risk, which is related to the uncertain futures basis. We usea one‐factor term structure model of futures convenience yields in order to construct a hedging strategythat minimizes both spot‐price risk and rollover risk by using futures of two different maturities. Themodel is tested using three commodity futures: crude oil, orange juice, and lumber. In theout‐of‐sample test, the residual variance of the 24‐month combined spot‐futurespositions is reduced by, respectively, 77%, 47%, and 84% compared to the variance of anaïve hedging portfolio. Even after accounting for the higher trading volume necessary to maintain atwo‐contract hedge portfolio, this risk reduction outweighs the extra trading costs for the investor withan average risk aversion. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:109–133, 2003