Disappointment aversion equilibrium in a futures market

This article examines the effect of disappointment aversion on the equilibrium in a commodity futures market. Consider a commodity market with a producer and a speculator. We show that the equilibrium price is positively related to either agent's risk or disappointment aversion, and to the market volatility. The market trading volume is positively related to the producer's risk or disappointment aversion, but negatively related to the speculator's risk or disappointment aversion. The producer lowers his or her reference point in response to an increase in the risk aversion or disappointment aversion of either agent, and to an increase in spot price volatility. The speculator raises his or her reference point when the producer becomes more risk averse or disappointment averse, or when the spot price becomes more volatile. A more disappointment‐averse speculator will lower his or her reference point. However, a more risk‐averse speculator raises (lowers) the reference point if he or she is less (more) risk averse than the producer. Numerical examples are provided to further support the above analytical results. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:135–150, 2003     

Futures Hedging Under Disappointment Aversion

This article considers optimal futures hedging decisions when the hedger is disappointment‐averse (Gul, 1991). When the futures contract is a perfect hedge instrument, a disappointment‐averse hedger always holds a position closer to the full hedge than a nondisappointment‐averse hedger. In the presence of basis risk, the optimal futures position is either a partial hedge or a full hedge. Neither Texas hedge nor overhedge could be optimal. The effects of different degrees of disappointment aversion on futures trading are also analyzed. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:1029–1042, 2001     

Futures hedging under mark‐to‐market risk

This article introduces mark‐to‐market risk into the conventional futures hedging framework. It is shown that a hedger concerned with maximum daily loss will considerably reduce his futures position when the risk is taken into account. In case of a moderate hedge horizon, the hedger will hedge approximately 80% of his spot position. The effect of mark‐to‐market risk decreases very slowly as the hedge horizon increases. If the hedger is concerned with average daily loss, the effect is minimal for a moderate hedge horizon. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:389–398, 2003     

A Note on Loss Aversion and Futures Hedging

This note examines the effect of loss aversion on the futures trading behavior of a short hedger. Using a modified constant‐absolute‐risk‐aversion utility function, I show that loss aversion has no effect in an unbiased futures market. It has different, predictable impacts when the futures market is in backwardation or contango. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21: 681–692, 2001     

Delivery risk and the hedging role of options

Multiple delivery specifications exist on nearly all commodity futures contracts. Sellers typically are allowed to deliver any of several grades of the underlying commodity and at any of several locations. On the delivery day, the futures price as such needs not converge to the spot price of the par‐delivery grade at the par‐delivery location, thereby imposing an additional delivery risk on hedgers. This article derives the optimal hedging strategy for a risk‐averse hedger in the presence of delivery risk. In particular, it is shown that the hedger optimally uses options on futures for hedging purposes. This article provides a rationale for the hedging role of options when futures markets allow for multiple delivery specifications. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:339–354, 2002     

What to do if a dollar is not a dollar? The impact of inflation risk on production and risk management

An entrepreneur faces two types of risk: one from income generation, one from income spending. His income from firm profits is risky due to output price fluctuations and other risks. As a consumer, he is also exposed to inflation risk since he maximizes expected utility of real income. This article focuses on optimal production and risk management decisions of a risk‐averse entrepreneur jointly facing tradable output price risk and untradable inflation risk. Inflation risk applies multiplicatively to the entrepreneur's entire nominal income. Relative risk aversion and the risks' joint distribution determine the effect of introducing a futures market on production. For dependent risks, this effect may be negative if relative risk aversion is above one. Relative risk aversion and the joint distribution also determine optimal risk management with futures contracts where speculation on a real risk premium and cross hedging may be conflicting objectives. © 2002 Wiley Periodicals, Inc. Jrl Fut Mark 22:371–386, 2002     

The effect of liquidity constraints on futures hedging

This article assumes that because of liquidity constraints, a hedge program will be terminated if the cumulative loss from a futures position exceeds a certain threshold. The constraint leads to a smaller futures position. If the hedger has a quadratic utility function, then the optimal futures position is constant regardless of the parameter values and increases as the spot position or the conventional hedge ratio increases. When the capital allocation is small, the hedger tends to ignore this restriction and chooses a larger position. Consequently, the optimal position may decrease as the capital allocation increases. For a moderate capital allocation, the optimal position increases with an increasing capital allocation. Similar properties are established for exponential utility functions. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:603–613, 2003     

Shortfall aversion

Shortfall aversion reflects the higher utility loss of spending cuts from a reference than the utility gain from similar spending increases. Inspired by Prospect Theory's loss aversion and the peak‐end rule, this paper posits a model of utility from spending scaled by past peak spending. In contrast to traditional models, which call for spending rates proportional to wealth, the optimal policy in this model implies a constant spending rate equal to the historical peak when wealth is relatively large. The spending rate increases when wealth reaches a model‐determined multiple of peak spending. In 1926–2015, shortfall‐averse spending is smooth and typically increasing.     

Testing the martingale hypothesis for futures prices: Implications for hedgers

The martingale hypothesis for futures prices is investigated using a nonparametric approach where it is assumed that the expected futures returns depend (nonparametrically) on a linear combination of predictors. We first collapse the predictors into a single‐index variable where the weights are identified up to scale, using the average derivative estimator proposed by T. Stoker (1986). We then use the Nadaraya–Watson kernel estimator to calculate (and visually depict) the relationship between the estimated index and the expected futures returns. We discuss implications of this finding for a noninfinitely risk‐averse hedger. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:1040–1065, 2008     

Relationship type,perceived trust,and ambiguity aversion

Ambiguity averse suggests consumers to prefer risky options over ambiguous ones. In this study, the authors propose that consumer–brand relationship types influence consumers’ ambiguity aversion. Specifically, compared with consumers in exchange relationships with the focal brand, consumers in communal relationships are more likely to trust the focal brand and thereby be less averse to ambiguity. These proposals were tested in two experiments. In experiment 1, participants in communal relationships showed less ambiguity aversion than those in exchange relationships. In experiment 2, participants in communal relationships had higher perceived trust with the focal brand than the participants in exchange relationships, and they showed less dislike for tensile promotions. Experiment 2 also tested for and confirmed the mediating effect of perceived trust. This study concludes with a discussion of the theoretical contributions and practical implications of the results.     

Does the More Risk‐Averse Investor hold a Less Risky Portfolio?*

We study the suitability of using absolute risk aversion as a measure of willingness to take risk in the Arrow–Debreu portfolio framework. We define a global measure of risk for the Arrow–Debreu portfolio, which is measured by the sensitivity of an individual's Arrow–Debreu portfolio payoff to the change in the market return. We call this measure ‘conservatism’ and show that the concept of ‘more conservative’ is stronger than that of ‘more risk‐averse.’ A higher absolute risk aversion is only necessary but not sufficient to induce a less risky Arrow–Debreu portfolio. Our results not only challenge the well‐accepted notion that a more risk‐averse investor holds a less risky portfolio, but also suggest a stronger measure – conservatism – for evaluating the riskiness of portfolio.     

A note on utility‐based futures hedging performance measure

This note considers the estimator for the utility‐based hedging performance. It shows that the estimator incurs a downward bias, regardless of whether the conventional mean‐variance expected utility function or the more general risk‐averse utility function is adopted. Consequently, the usefulness of the futures contract is under‐estimated. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark     

Feeling red lucky? The interplay between color and luck in gambling settings

This paper investigates the effect of the color red on gambling behavior, as influenced by feeling lucky and cultural background. Four experiments examine how risk‐taking choices and gambling behaviors are affected. Study 1A and 1B establish the red risk‐aversion effect in gambling decision making and responses to a gambling app advert. Studies 2 and 3 test the moderating effect of feeling lucky and cultural background, respectively. The authors provide empirical evidence to the effect of red color on risk aversion. In general, people make more risk averse choices, gambling less and less often when primed with the color red over other colors. Boundary conditions are identified in feeling lucky and cultural backgrounds, such that when participants feel lucky or are from Asian Chinese backgrounds the effect is reversed and they take more risks when primed with the color red. This study highlights the importance of color in managing the interaction between consumers and gambling contexts.     

Investor Sentiment and Return Predictability in Agricultural Futures Markets

This study examines the usefulness of trader‐position‐based sentiment index for forecasting future prices in six major agricultural futures markets. It has been found that large speculator sentiment forecasts price continuations. In contrast, large hedger sentiment predicts price reversals. Small trader sentiment hardly forecasts future market movements. An investigation was performed into various sentiment‐based timing strategies, and it was found that the combination of extreme large trader sentiments provides the strongest timing signal. These results are generally consistent with the hedging‐pressure theory, suggesting that hedgers pay risk premiums to transfer nonmarketable risks in futures markets. Moreover, it does not appear that large speculators in the futures markets possess any superior forecasting ability. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:929–952, 2001     

Production,liquidity, and futures price dynamics

This study examines the optimal design of a futures hedge program for the competitive firm under output price uncertainty. All futures contracts are unbiased and marked to market in that they require interim cash settlement of gains and losses. The futures price dynamics follows a first-order autoregression with a random walk serving as a special case. The firm's futures hedge program is constituted of an endogenous provision for premature termination, which depends on how the futures prices are autocorrelated. Succinctly, the firm voluntarily commits to premature liquidation of its futures position on which the interim loss incurred exceeds a predetermined threshold level if the futures prices are positively autocorrelated. In this case, the liquidity constrained firm optimally opts for an over-hedge if its preferences exhibit either constant or increasing absolute risk aversion. If the futures prices are uncorrelated or negatively autocorrelated, the firm prefers to be liquidity unconstrained and thus adopts a full-hedge to completely eliminate the output price risk. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:749–762, 2008     

The effects of loss aversion on trade policy: Theory and evidence

We study the implications of loss aversion for trade policy determination and show how it allows us to explain a number of important and puzzling features of trade policy. Some important questions concerning trade policy are why a disproportionate share of protection goes to declining industries and why trade policy has an anti-trade bias. We show that if individual preferences exhibit sufficient loss aversion, higher protection will be given to sectors in which profitability is declining. We also show that if the coefficient of loss aversion is large enough, there will be an anti-trade bias in trade policy. Using a nonlinear regression procedure, we find support for the model and the estimates of the loss aversion parameters are very close to those obtained by Kahneman and Tversky (Kahneman, D., Tversky, A., 1992. Advances in Prospect Theory: Cumulative Representation of Uncertainty. Journal of Risk and Uncertainty 5, 297-323.) with experimental data. Protection is found to be more responsive to losses than to gains, and the estimates of the coefficient of loss aversion are about 2. We also find evidence of loss aversion in lobby formation.     

When to sell an asset amid anxiety about drawdowns

We consider risk‐averse investors with different levels of anxiety about asset price drawdowns. The latter is defined as the distance of the current price away from its best performance since inception. These drawdowns can increase either continuously or by jumps, and will contribute toward the investor's overall impatience when breaching the investor's private tolerance level. We investigate the unusual reactions of investors when aiming to sell an asset under such adverse market conditions. Mathematically, we study the optimal stopping of the utility of an asset sale with a random discounting that captures the investor's overall impatience. The random discounting is given by the cumulative amount of time spent by the drawdowns in an undesirable high region, fine‐tuned by the investor's personal tolerance and anxiety about drawdowns. We prove that in addition to the traditional take‐profit sales, the real‐life employed stop‐loss orders and trailing stops may become part of the optimal selling strategy, depending on different personal characteristics. This paper thus provides insights on the effect of anxiety and its distinction with traditional risk aversion on decision making.     

Production and hedging under state‐dependent preferences

This study examines the behavior of the competitive firm under output price uncertainty and state‐dependent preferences. When there is a futures market for hedging purposes, the firm's optimal production decision is independent of the output price uncertainty and of the state‐dependent preferences. If the futures contracts are unbiased, the firm's optimal futures position is an over‐hedge or an under‐hedge, depending on whether the firm is correlation averse or correlation loving, and on whether the output price is positively or negatively expectation dependent on the state variable. When the firm has access not only to the unbiased futures but also to fairly priced options, sufficient conditions are derived under which the firm's optimal hedge position includes both hedging instruments. This study thus establishes a hedging role of options, which is over and above that of futures, in the case of state‐dependent preferences. © 2011 Wiley Periodicals, Inc. Jrl Fut Mark 32:945–963, 2012     

Futures market equilibrium under Knightian uncertainty

This paper examines the effects of Knightian uncertainty on a commodity futures market within the Newbery‐Stiglitz framework. It is shown that Knightian traders act more conservatively. In a partial trade equilibrium, risk aversion and Knightian uncertainty have qualitatively similar effects on the equilibrium price and the equilibrium trading volume. Full‐trade and no‐trade equilibria are likely to prevail when the producer and the speculator incur different Knightian uncertainty. Herein different impacts of risk aversion and Knightian uncertainty are observed. © 2003 Wiley Periodicals, Inc. Jrl Fut Mark 23:701–718, 2003     

Optimal Currency Composition for China's Foreign Reserves: A Copula Approach

This paper investigates the optimal currency composition for a country's foreign reserves. In the context of China, we examine the asymmetric, fat‐tail and complex dependence structure in distributions of currency returns. A skewed, fat‐tailed and pair‐copula construction is then built to capture features of higher moments. In a D‐vine copula approach, we show that under the disappointment aversion effect, the central bank in our model can achieve sizeable gains in expected economic value from switching from the mean‐variance to copula modelling. We find that this approach will lead to an optimal currency composition that allows China to have more space for international currency diversification while maintaining the leading position of the US dollar in the currency shares of China's reserves.