Hedging long-run commodity flow commitments under stochastic convenience yield
Godbey, Jonathan Manley
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A massive futures market has evolved to enable firms to alter their exposure to various commodity prices, interest rate and currency movements. Unfortunately, the appropriate hedging strategy is not always readily apparent. The large bid-ask spread of long-dated futures contracts often makes hedging too expensive. Absent a futures market with sufficient liquidity to make a stripped hedge cost efficient, the firm must find an alternative strategy. This dissertation will describe the method to find the minimum variance hedging strategy under stochastic convenience yield. Tests of the strategy will be done on oil, gold, copper, soybeans and Yen. Simulated and actual data are used to compare the variance of the unhedged or spot position, a rollover hedge and the naïve stacked hedge with the stochastic convenience yield hedge and its approximations. The naive stacked hedge shows a reduction in variance when compared to both the unhedged position and the rollover hedge for all five assets. The stochastic convenience yield hedge is the minimum variance position for the commodities which exhibit convenience yield -- oil, copper and soybeans. Since gold and Yen do not exhibit convenience yield the stochastic convenience yield hedge and its approximations are virtually identical to the naive stacked hedge.