Economic Hedging Portfolios

Tilburg University Working Paper

31 Pages Posted: 22 May 2003

See all articles by Rob W. J. van den Goorbergh

Rob W. J. van den Goorbergh

Tilburg University - Department of Finance

Frans de Roon

Tilburg University - Department of Finance

Bas J. M. Werker

Tilburg University - Center for Economic Research (CentER)

Date Written: February 28, 2003

Abstract

In this paper we study portfolios that investors hold to hedge various economic risks. We also consider the risk premiums associated with these economic hedging portfolios for various types of agents. Using a model of state-dependent utility, we show that agents' economic hedging portfolios can be obtained by an intuitively appealing risk aversion-weighted approximate replication of the economic risk variables using the available risky security returns, as opposed to the unweighted hedging demand obtained in a traditional mean-variance framework.

We find that agents across a broad range of levels of risk aversion are willing to pay significant risk premiums for hedges against three sources of economic risk: Inflation risk, real interest-rate risk, and dividend-yield risk. Furthermore, our results show that all economic risk variables we consider require a significant hedging adjustment with respect to one or more securities. Some of these securities prove to be useful hedging instruments across different types of investors, whereas others only serve as hedges for particular levels of risk aversion, which demonstrates the empirical relevance of risk aversion-weighted hedging.

Moreover, we analyze investors' speculative positions and find that hedges against economic risks may potentially explain the anomalies found in stock markets as well as the term and default premiums in bond markets.

Keywords: Economic hedging portfolios, risk aversion-weighted hedging, state-dependent utility, risk premiums

JEL Classification: G10, G11

Suggested Citation

van den Goorbergh, Rob W. J. and de Roon, Frans A. and Werker, Bas J.M., Economic Hedging Portfolios (February 28, 2003). Tilburg University Working Paper. Available at SSRN: https://ssrn.com/abstract=384041 or http://dx.doi.org/10.2139/ssrn.384041

Rob W. J. Van den Goorbergh (Contact Author)

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 8222 (Phone)

Frans A. De Roon

Tilburg University - Department of Finance ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 1 3466 8361/3025 (Phone)
+31 1 3466 2875 (Fax)

Bas J.M. Werker

Tilburg University - Center for Economic Research (CentER) ( email )

Econometrics and Finance Group
5000 LE Tilburg
Netherlands

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