Hedging Mean-Reverting Commodities
11 Pages Posted: 6 Nov 2008
Date Written: November 1, 2008
This paper uses the expected utility framework to examine the optimal hedging decision for commodities with mean reverting price processes. The derived results show that when commodity prices follow a mean reverting process, the optimal hedge ratio differs significantly from the classical results found under standard geometric Brownian motion. Hence a failure to accommodate mean reversion when it exists can lead to systematic biases in hedging and investment decisions respectively.
Keywords: Commodity risk, investment under uncertainty, hedging, mean-reverting
JEL Classification: G12, G13, F34, G21
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