Hedging Mean-Reverting Commodities

11 Pages Posted: 6 Nov 2008

See all articles by Udo Broll

Udo Broll

Dresden University of Technology - Faculty of Economics and Business Management

Ephraim Clark

Middlesex University Business School

Elmar Lukas

Otto-von-Guericke University Magdeburg, Faculty of Economics and Management - Chair in Financial Management and Innovation Finance

Date Written: November 1, 2008

Abstract

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

Suggested Citation

Broll, Udo and Clark, Ephraim and Lukas, Elmar, Hedging Mean-Reverting Commodities (November 1, 2008). Available at SSRN: https://ssrn.com/abstract=1295909 or http://dx.doi.org/10.2139/ssrn.1295909

Udo Broll (Contact Author)

Dresden University of Technology - Faculty of Economics and Business Management ( email )

Mommsenstrasse 13
Dresden, D-01062
Germany

Ephraim Clark

Middlesex University Business School ( email )

The Burroughs
London, NW4 4BT
United Kingdom

Elmar Lukas

Otto-von-Guericke University Magdeburg, Faculty of Economics and Management - Chair in Financial Management and Innovation Finance ( email )

Universitaetsplatz 2
Postfach 4120
Magdeburg, 39106
Germany
+49 391 67 18934 (Phone)
+49 391 67 18007 (Fax)

HOME PAGE: http://www.ifm.ovgu.de

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