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Derivative trading by utility firms
Authors:Karyl B Leggio  Donald Lien
Institution:(1) Department of Finance, University of Kansas, Summerfield Hall, 66045-2003 Lawrence, KS;(2) Department of Economics, University of Kansas, Summerfield Hall, 66045-2003 Lawrence, KS
Abstract:This paper examines the use of derivatives by a utility company. The hedging problem for utilities is atypical; the goal is not strictly to minimize average costs. Rather, the objectives are to minimize the upside risk associated with extreme bills, volatility of bills, and average expected bills for consumers. We characterize the optimal positions on futures contracts and options on futures that a utility company should assume. The results indicate that the use of derivatives (both futures and options on futures) is an efficient means of optimizing the objective functions without exposing consumers to speculative risk.
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