Does Speculation in Futures Markets Improve Hedging Decisions?

Abstract

This article compares traditional hedging that aims at covering spot price risk and selective hedging that also speculates by forecasting futures price changes. The selective hedges we consider use different forecasts that range from the historical average return to (V)AR model projections, combinations of univariate regression forecasts, and optimally integrated predictive signals. We compare the effectiveness of the various hedges in terms of their ability to maximize expected utility and reduce risk. An out-of-sample analysis applied to 24 commodities endorses traditional hedging on both accounts which can be rationalized by the absence of a risk premium at the individual commodity level. The findings are not period-specific and survive transaction costs, longer estimation windows, and weekly versus monthly rebalancing frequencies, inter alia.

Keywords: Selective hedging; Expected utility; Risk minimization; Commodity futures markets

JEL Classification: G13, G14