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Optimal Hedging with a Subjective View: An Empirical Bayesian Approach
Author(s) -
Shi Wei,
Irwin Scott H.
Publication year - 2005
Publication title -
american journal of agricultural economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.949
H-Index - 111
eISSN - 1467-8276
pISSN - 0002-9092
DOI - 10.1111/j.1467-8276.2005.00778.x
Subject(s) - econometrics , certainty , normative , bayesian probability , empirical research , bayesian inference , estimation , computer science , economics , bayes' theorem , mathematics , statistics , artificial intelligence , philosophy , geometry , management , epistemology
The standard optimal hedging model has been the preferred theoretical model of normative hedging behavior. In empirical applications, the model is often implemented with the parameter certainty equivalent (PCE) procedure. However, the PCE procedure completely ignores parameter estimation risk and subjective views. We develop an “empirical” Bayesian optimal hedging model that not only effectively accommodates parameter estimation risk, but also provides hedgers with a theoretically intuitive yet quantitatively rigorous framework to blend their subjective views and a “marketwide” or “firmwide” consensus in determining optimal hedging positions (ratios).