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Adjusting stacked-hedge ratios for stochastic convenience yield: a minimum variance approach

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  • Jonathan M. Godbey
  • Jimmy E. Hilliard

Abstract

Absent liquidity in long-term futures or forward markets, firms use nearby contracts to hedge long-term commitments. To hedge commodities that exhibit stochastic convenience yield, adjustments to the naive stacked hedge are necessary. Simulated and empirical tests of the hedging model using oil, copper, soybeans, gold and yen show that a stacked hedge reduces the volatility of terminal wealth. For commercial commodities, adjusting the hedge for stochastic convenience yield further reduces volatility. Kalman filter methods are used to estimate the parameters in the underlying.

Suggested Citation

  • Jonathan M. Godbey & Jimmy E. Hilliard, 2007. "Adjusting stacked-hedge ratios for stochastic convenience yield: a minimum variance approach," Quantitative Finance, Taylor & Francis Journals, vol. 7(3), pages 289-300.
    • Handle: RePEc:taf:quantf:v:7:y:2007:i:3:p:289-300
    DOI: 10.1080/14697680600989535
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    References listed on IDEAS

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    Cited by:

    1. James DiLellio, 2015. "A Kalman filter control technique in mean-variance portfolio management," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 39(2), pages 235-261, April.
    2. Luo, Rui & Fortenbery, T. Randall, 2016. "Corporate Hedging In Incomplete Markets: A Solution Under Price Transmission," 2016 Annual Meeting, July 31-August 2, Boston, Massachusetts 235444, Agricultural and Applied Economics Association.

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