Does Speculation in Futures Markets Improve Commodity Hedging Decisions?
47 Pages Posted: 7 Dec 2022 Last revised: 18 Feb 2024
Date Written: November 28, 2022
This article performs a comparative analysis of traditional and selective hedging strategies in commodity futures markets. Traditional hedging is aimed solely at reducing the risk of the commodity spot positions, whereas selective hedging additionally pursues economic gains by engaging in speculation based on the hedger’s prediction of the commodity futures return. We construct selective hedges using diverse forecasting approaches that range from the naïve historical average to more sophisticated techniques such as machine learning. The hedging strategies are assessed through the less of hedging effectiveness based on the expected mean-variance utility of the hedged returns. Out-of-sample results for 24 commodities endorse traditional over selective hedging, as the latter increases risk but fails to generate additional returns. The findings survive various reformulations of the hedges, longer estimation windows, and alternative rebalancing frequencies, inter alia.
Keywords: Selective hedging; Expected utility; Risk minimization; Commodity futures markets
JEL Classification: G13, G14
Suggested Citation: Suggested Citation