Optimal Corporate Hedging Using Options with Basis and Production Risk

North American Journal of Economics and Finance, Vol. 30, pp. 56-71, 2014

Posted: 29 Aug 2014 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

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Date Written: August 18, 2014

Abstract

We investigate the optimal hedging strategy for a firm using options, where the role of production and basis 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. Also, we decompose the effect of production and basis risk showing that the former affects hedging effectiveness while the latter drives the choice of the optimal contract. Fitting the model parameters to match a financial turmoil scenario confirms that 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 (August 18, 2014). North American Journal of Economics and Finance, Vol. 30, pp. 56-71, 2014. Available at SSRN: https://ssrn.com/abstract=2487998

Emanuele Bajo

University of Bologna - Department of Economics ( email )

Bologna
Italy

Massimiliano Barbi (Contact Author)

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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