Optimal corporate hedging using options with basis and production risk |
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| Institution: | 1. Department of Management, University of Bologna, via Capo di Lucca 34, 40126 Bologna, Italy;2. Department of Statistics, University of Bologna, Via Belle Arti 41, 40126 Bologna, Italy;1. Accounting and Finance, Faculty of Business and Public Administration, University of Zaragoza, Plaza de la Constitución s/n, Huesca 22003, Spain;2. Quantitative Methods Department, Economics Faculty, University of Zaragoza, C\\ Gran Vía no. 2, Zaragoza 50018, Spain;3. Accounting and Finance, Economics Faculty, University of Zaragoza, C\\ Gran Vía no. 2, Zaragoza 50018, Spain;1. Faculty of Economics, University of Belgrade, Kameni?ka 6, 11000 Belgrade, Serbia;2. Moody''s Analytics UK Limited, One Canada Square, Canary Wharf, London E14 5FA, United Kingdom;1. Department of Economics, Faculty of Business and Economics, Eastern Mediterranean University, Cyprus;2. Department of Economics, Stellenbosch University, South Africa;3. Department of Economics, University of Pretoria, Pretoria 0002, South Africa;1. Kabarak University, Private Bag 20157, Nakuru, Kenya;2. University of the Witwatersrand, PO Box 98, Johannesburg, South Africa;1. Department of International Business, Chung Yuan Christian University, Taiwan, R.O.C.;2. Gaming Teaching and Research Centre, Macao Polytechnic Institute, China;3. Department of Finance, National Central University, Taiwan, R.O.C. |
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| Abstract: | We investigate the optimal hedging strategy for a firm using options, where the role of production and basis risk are considered. Contrary to the existing literature, we find that the exercise price which minimizes the shortfall of the hedged portfolio is primarily affected by the amount of cash spent on the hedging. Also, we decompose the effect of production and basis risk showing that the former affects hedging effectiveness while the latter drives the choice of the optimal contract. Fitting the model parameters to match a financial turmoil scenario confirms that suboptimal option moneyness leads to a non-negligible economic loss. |
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| Keywords: | Risk management Option hedging Expected shortfall |
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