Risk Management with Options and Futures under Liquidity Risk

Journal of Futures Markets, Forthcoming

Posted: 18 Aug 2008

See all articles by Axel F. A. Adam-Muller

Axel F. A. Adam-Muller

University of Trier, Fachbereich IV - BWL

Argyro Panaretou

Lancaster University - Lancaster University Management School

Abstract

Futures hedging creates liquidity risk through marking to market. Liquidity risk matters if interim losses on a futures position have to be financed at a markup over the risk-free rate. This paper analyzes the optimal risk management and production decisions of a firm facing joint price and liquidity risk. It provides a rationale for the use options on futures in imperfect capital markets. If liquidity risk materializes, the firm sells options on futures in order to partly cover this liquidity need. It is shown that liquidity risk reduces the optimal hedge ratio and that options are not normally used before a liquidity need actually arises.

Keywords: liquidity risk, risk management, options on futures, futures

JEL Classification: G11, D81

Suggested Citation

Adam-Muller, Axel F. A. and Panaretou, Argyro, Risk Management with Options and Futures under Liquidity Risk. Journal of Futures Markets, Forthcoming , Available at SSRN: https://ssrn.com/abstract=1234122

Axel F. A. Adam-Muller (Contact Author)

University of Trier, Fachbereich IV - BWL ( email )

Trier, D-54296
Germany
+49-651-2012725 (Phone)
+49-651-201-3841 (Fax)

HOME PAGE: http://finance.uni-trier,de

Argyro Panaretou

Lancaster University - Lancaster University Management School ( email )

Bailrigg
Lancaster, LA1 4YX
United Kingdom

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