Veld-Merkoulova, Y. and de Roon, F.A. (2003) Hedging long-term commodity risk. Journal of Futures Markets, 23(2), pp. 109-133. (doi: 10.1002/fut.10060)
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Abstract
This study focuses on the problem of hedging longer-term commodity positions, which often arises when the maturity of actively traded futures contracts on this commodity is limited to a few months. In this case, using a rollover strategy results in a high residual risk, which is related to the uncertain futures basis. We use a one-factor term structure model of futures convenience yields in order to construct a hedging strategy that minimizes both spot-price risk and rollover risk by using futures of two different maturities. The model is tested using three commodity futures: crude oil, orange juice, and lumber. In the out-of-sample test, the residual variance of the 24-month combined spot-futures positions is reduced by, respectively, 77%, 47%, and 84% compared to the variance of a naïve hedging portfolio. Even after accounting for the higher trading volume necessary to maintain a two-contract hedge portfolio, this risk reduction outweighs the extra trading costs for the investor with an average risk aversion.
| Item Type: | Articles |
|---|---|
| Status: | Published |
| Refereed: | Yes |
| Glasgow Author(s) Enlighten ID: | Veld-Merkoulova, Professor Yulia |
| Authors: | Veld-Merkoulova, Y., and de Roon, F.A. |
| College/School: | College of Social Sciences > Adam Smith Business School > Accounting and Finance |
| Journal Name: | Journal of Futures Markets |
| ISSN: | 0270-7314 |
| ISSN (Online): | 1096-9934 |
| Published Online: | 19 December 2002 |
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