A Generalized Approach to Optimal Hedging with Option Contracts

European Journal of Finance, Vol. 21, pp. 714-733, 2015

Posted: 22 Nov 2013 Last revised: 13 May 2015

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

Date Written: November 18, 2013

Abstract

In this paper we develop a theoretical model in which a firm hedges a spot position using options in presence of both quantity (production) and basis risk. Our optimal hedge ratio is fairly general, in that the dependence structure is modelled through a copula function representing the quantiles of the hedged position, and hence any quantile risk measure can be employed. We study the sensitivity of the exercise price which minimizes the risk of the hedged portfolio to the relevant parameters, and we find that the subjective risk aversion of the firm does not play any role. The only trade-off is between the effectiveness and the cost of the hedging strategy.

Keywords: Optimal hedge ratio, Option hedging, Spectral risk measures, Copula function.

JEL Classification: G10, G32

Suggested Citation

Bajo, Emanuele and Barbi, Massimiliano and Romagnoli, Silvia, A Generalized Approach to Optimal Hedging with Option Contracts (November 18, 2013). European Journal of Finance, Vol. 21, pp. 714-733, 2015. Available at SSRN: https://ssrn.com/abstract=2358326

Emanuele Bajo

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 (Contact Author)

University of Bologna - Department of Statistics ( email )

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