Hedging Long-Term Forwards with Short-Term Futures: A Two-Regime Approach

Bühler, Wolfgang; Korn, Olaf; Schöbel, Rainer
December 2004
Review of Derivatives Research;2004, Vol. 7 Issue 3, p185
Academic Journal
In this paper we investigate Metallgesellschaft’s problem of hedging long-term forwards with short-term futures. Very different hedging strategies have been proposed in the literature. We attribute these differences to the underlying valuation approaches for oil futures and empirically compare five model-based hedging strategies. In particular, we consider a strategy which results from a two-regime pricing model. This continuous-time equilibrium model reflects the observation that prices of oil futures exhibit a very different behavior for low and high oil prices. Our empirical study shows that time diversification is the dominant effect for an effective hedging of long-term oil forwards with short-term futures.


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