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Downside Risk and the Energy Hedger's Horizon

27 Pages Posted: 13 Sep 2012 Last revised: 5 Nov 2014

Thomas Conlon

University College Dublin

John Cotter

University College Dublin; Anderson School of Management

Date Written: September 13, 2012

Abstract

In this paper, we explore the impact of investor time-horizon on an optimal downside hedged energy portfolio. Previous studies have shown that minimum-variance hedging effectiveness improves for longer horizons using variance as the performance metric. This paper investigates whether this result holds for different hedging objectives and effectiveness measures. A wavelet transform is applied to calculate the optimal heating oil hedge ratio using a variety of downside objective functions at different time-horizons. We demonstrate decreased hedging effectiveness for increased levels of uncertainty at higher confidence intervals. Moreover, for each of the different hedging objectives and effectiveness measures studied, we also demonstrate increasing hedging effectiveness at longer horizons. While small differences in effectiveness are found across the different hedging objectives, time-horizon effects are found to dominate confirming the importance of considering the hedgers horizon. The findings suggest that while downside risk measures are useful in the computation of an optimal hedge ratio that accounts for unwanted negative returns, hedging horizon and confidence intervals should also be given careful consideration by the energy hedger.

Keywords: energy hedging, futures hedging, wavelet transform, hedging horizon, downside risk

JEL Classification: G10, G15

Suggested Citation

Conlon, Thomas and Cotter, John, Downside Risk and the Energy Hedger's Horizon (September 13, 2012). Energy Economics, Vol. 36, 2013. Available at SSRN: https://ssrn.com/abstract=2145831 or http://dx.doi.org/10.2139/ssrn.2145831

Thomas Conlon (Contact Author)

University College Dublin ( email )

Smurfit Graduate Business School
Blackrock
Co. Dublin, n/a
Ireland

HOME PAGE: http://www.ucd.ie/bankingfinance/staff/drthomasconlon/

John Cotter

Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

University College Dublin ( email )

School of Business, Carysfort Avenue
Blackrock, Co. Dublin
Ireland
353 1 716 8900 (Phone)
353 1 283 5482 (Fax)

HOME PAGE: http://www.ucd.ie/bankingfinance/staff/professorjohncotter/

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