Optimal Hedging under Forward-Looking Behavior

Sergio H. Lence, Dermot J. Hayes
June 1993  [93-WP 108]

The study focuses on the production and hedging behavior of forward-looking risk-averse competitive firms. It is shown that there is separation between production and hedging. Optimal production for a forward-looking firm is identical to that of an otherwise equivalent myopic firm. However, the optimal forward-looking hedge differs from the optimal myopic hedge. If forward prices are unbiased, full hedging is suboptimal when the firm is forward-looking and output and material input prices are contemporaneously related. Furthermore, under certain conditions, the optimal forward-looking hedge under unbiased forward prices is strictly smaller than the full hedge.

Keywords: Futures, hedging, forward-looking decision making.

JEL classification: D81, G13

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