Optimal Corporate Hedging Using Options with Basis and Production Risk

29 Pages Posted: 28 Sep 2012

See all articles by Emanuele Bajo

Emanuele Bajo

University of Bologna - Department of Economics

Massimiliano Barbi

University of Bologna - Department of Management

Silvia Romagnoli

University of Bologna - Department of Statistics

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Date Written: September 28, 2012

Abstract

In this paper we investigate the optimal hedging strategy for a firm using option contracts, where both the role of production (quantity) and basis (proxy) risk are considered. Contrary to the existing literature, we find that the exercise price which minimizes the shortfall of the hedged portfolio is primarily affected by the amount of cash spent on the hedging program. Also, we decompose the effect of quantity and proxy risk showing that the latter greatly affects hedging effectiveness while the former drives the choice of the optimal option contract. Finally, fitting the model parameters to match a financial turmoil scenario confirms that choosing a suboptimal option moneyness leads to a non-negligible economic loss.

Keywords: Risk management, Option hedging, Expected shortfall

JEL Classification: G30, G32

Suggested Citation

Bajo, Emanuele and Barbi, Massimiliano and Romagnoli, Silvia, Optimal Corporate Hedging Using Options with Basis and Production Risk (September 28, 2012). Available at SSRN: https://ssrn.com/abstract=2153840 or http://dx.doi.org/10.2139/ssrn.2153840

Emanuele Bajo (Contact Author)

University of Bologna - Department of Economics ( email )

Bologna
Italy

Massimiliano Barbi

University of Bologna - Department of Management ( email )

via Capo di Lucca 34
Bologna, 40126
Italy
+39 051 2098404 (Phone)
+39 051 246411 (Fax)

HOME PAGE: http://www.sites.google.com/site/massimilianobarbifinance/

Silvia Romagnoli

University of Bologna - Department of Statistics ( email )

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