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How to hedge if the payment date is uncertain?

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  • Korn, Olaf
  • Merz, Alexander

Abstract

This paper is the first to study the hedging of price risk with uncertain payment dates, a frequent problem in practice. It derives a variance-minimizing hedging strategy for two settings, the first employing linear contracts with different times to maturity and the second allowing for non-linear exotic derivatives. Using commodity prices and exchange rates, we empirically show the optimal strategy clearly outperforms heuristic alternatives in both settings. Non-linear instruments offer advantages with increasing hedge horizons and strongly dependent time and price risk, while linear instruments can suffice for short horizons and weak dependency.

Suggested Citation

  • 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).
    • Handle: RePEc:zbw:cfrwps:0714r
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    References listed on IDEAS

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    More about this item

    Keywords

    risk management; hedging; forwards; exotic derivatives; time uncertainty;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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