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Risk management with options and futures under liquidity risk

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  • Axel F. A. Adam‐Müller
  • Argyro Panaretou

Abstract

Futures hedging creates liquidity risk through marking to market. Liquidity risk matters if interim losses on a futures position have to be financed at a markup over the risk‐free rate. This study analyzes the optimal risk management and production decisions of a firm facing joint price and liquidity risk. It provides a rationale for the use of options on futures in imperfect capital markets. If liquidity risk materializes, the firm sells options on futures in order to partly cover this liquidity need. It is shown that liquidity risk reduces the optimal hedge ratio and that options are not normally used before a liquidity need actually arises. © 2009 Wiley Periodicals, Inc. Jrl Fut Mark 29:297–318, 2009

Suggested Citation

  • Axel F. A. Adam‐Müller & Argyro Panaretou, 2009. "Risk management with options and futures under liquidity risk," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 29(4), pages 297-318, April.
    • Handle: RePEc:wly:jfutmk:v:29:y:2009:i:4:p:297-318
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    Cited by:

    1. Akron, Sagi, 2019. "The optimal derivative-based corporate hedging strategies under equity-linked managerial compensation," Emerging Markets Review, Elsevier, vol. 41(C).
    2. Beccarini, Andrea, 2014. "Solving the liquidity constraint by options on futures," Journal of Mathematical Economics, Elsevier, vol. 51(C), pages 116-120.
    3. Marin Bozic, 2010. "Pricing Options on Commodity Futures: The Role of Weather and Storage," Working Papers 1003, The Institute of Economics, Zagreb.
    4. Korn, Olaf & Rieger, Marc Oliver, 2016. "Hedging with regret," CFR Working Papers 16-06, University of Cologne, Centre for Financial Research (CFR).
    5. Elisson Andrade & Fabio Mattos & Roberto Arruda de Souza Lima, 2018. "New Insights on Hedge Ratios in the Presence of Stochastic Transaction Costs," Risks, MDPI, vol. 6(4), pages 1-15, October.
    6. Korn, Olaf & Merz, Alexander, 2016. "How to hedge if the payment date is uncertain?," CFR Working Papers 07-14 [rev.], University of Cologne, Centre for Financial Research (CFR).
    7. Korn, Olaf & Rieger, Marc Oliver, 2019. "Hedging with regret," Journal of Behavioral and Experimental Finance, Elsevier, vol. 22(C), pages 192-205.
    8. Benzennou, Bouchra & ap Gwilym, Owain & Williams, Gwion, 2020. "Commonality in liquidity across options and stock futures markets," Finance Research Letters, Elsevier, vol. 32(C).
    9. Olaf Korn & Alexander Merz, 2019. "How to hedge if the payment date is uncertain?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(4), pages 481-498, April.

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