How to Hedge if the Payment Date Is Uncertain

54 Pages Posted: 22 Aug 2011 Last revised: 14 May 2016

See all articles by Olaf Korn

Olaf Korn

Georg-August-Universität Göttingen

Alexander Merz

University of Goettingen

Date Written: August 1, 2011

Abstract

This paper studies the hedging of price risk if the payment date is uncertain, a problem that frequently occurs in practice. It derives and establishes the variance-minimizing hedging strategy, using forward contracts with different times to maturity. The resulting strategy fully hedges the expected price exposure for each possible payment date and is therefore easy to implement. An empirical study compares the performance of the variance-minimizing strategy with heuristic alternatives, using commodity prices and exchange rates. Our analysis shows that the variance-minimizing strategy clearly outperforms all the alternatives.

Keywords: risk management, hedging, forwards, uncertainty of time

JEL Classification: G30, D81

Suggested Citation

Korn, Olaf and Merz, Alexander, How to Hedge if the Payment Date Is Uncertain (August 1, 2011). 24th Australasian Finance and Banking Conference 2011 Paper. Available at SSRN: https://ssrn.com/abstract=1914373 or http://dx.doi.org/10.2139/ssrn.1914373

Olaf Korn (Contact Author)

Georg-August-Universität Göttingen ( email )

Platz der Göttinger Sieben 3
D-37073 Göttingen
Germany

Alexander Merz

University of Goettingen ( email )

Platz der Göttinger Sieben 3
Göttingen, 37073
Germany

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