State-Dependent Preferences and Futures Hedging: The Effects of Basis Risk

7 Pages Posted: 2 Jul 2004

See all articles by Donald D. Lien

Donald D. Lien

University of Texas at San Antonio - College of Business - Department of Economics

Abstract

This note incorporates basis risk into the futures hedging decision-making problem when the hedger has a state-dependent preference. It is shown that, in an unbiased futures market, a partial hedge is optimal when the marginal utilities in different states are moderately close to each other. Conditions for a Texas hedge or an overhedge are provided. Finally, it is demonstrated that basis risk always reduces the futures trading volume.

Suggested Citation

Lien, Donald, State-Dependent Preferences and Futures Hedging: The Effects of Basis Risk. Pacific Economic Review, Vol. 9, No. 2, pp. 143-149, June 2004. Available at SSRN: https://ssrn.com/abstract=551226

Donald Lien (Contact Author)

University of Texas at San Antonio - College of Business - Department of Economics ( email )

6900 North Loop 1604 West
San Antonio, TX 78249
United States
210-458-4313 (Phone)
210-458-4308 (Fax)

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