How Firms Should Hedge: An Extension
9 Pages Posted: 20 Feb 2008
Date Written: February 20, 2008
Abstract
This note studies a firm's optimal hedging strategy with tailor-made exotic derivatives under both price risk and quantity risk. It extends the analysis of Brown and Toft (2002) by relaxing the distributional assumptions. The optimal pay-off function of a derivative contract is characterized in terms of the expectation and variance of the quantity, conditional on the price. This main result is illustrated by different examples, stressing the importance of the dependence structure between price risk and quantity risk for the choice of appropriate hedging instruments.
Keywords: risk management, hedging, quantity risk, exotic derivatives
JEL Classification: G30, D81
Suggested Citation: Suggested Citation
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