Optimal Hedging with a Subjective View: An Empirical Bayesian Approach

13 Pages Posted: 21 Apr 2020

See all articles by Wei Shu

Wei Shu

University of Illinois at Urbana-Champaign

Scott H. Irwin

University of Illinois at Urbana-Champaign

Date Written: November 2005

Abstract

The standard optimal hedging model has been the preferred theoretical model of normative hedging behavior. In empirical applications, the model is often implemented with the parameter certainty equivalent (PCE) procedure. However, the PCE procedure completely ignores parameter estimation risk and subjective views. We develop an “empirical” Bayesian optimal hedging model that not only effectively accommodates parameter estimation risk, but also provides hedgers with a theoretically intuitive yet quantitatively rigorous framework to blend their subjective views and a “marketwide” or “firmwide” consensus in determining optimal hedging positions (ratios).

Keywords: Bayesian analysis, optimal hedging, parameter estimation risk, subjective view

Suggested Citation

Shu, Wei and Irwin, Scott, Optimal Hedging with a Subjective View: An Empirical Bayesian Approach (November 2005). American Journal of Agricultural Economics, Vol. 87, Issue 4, pp. 918-930, 2005, Available at SSRN: https://ssrn.com/abstract=3581156 or http://dx.doi.org/10.1111/j.1467-8276.2005.00778.x

Wei Shu (Contact Author)

University of Illinois at Urbana-Champaign

601 E John St
Champaign, IL 61820
United States

Scott Irwin

University of Illinois at Urbana-Champaign ( email )

344 Mumford Hall
1301 W. Gregory Dr.
Urbana, IL 61801
United States
217-333-6087 (Phone)

HOME PAGE: http://https://scotthirwin.com/

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