Hedging price risk when real wealth matters

Axel F.A. Adam-Müller (Center of Finance and Econometrics, Department of Economics and Statistics, University of Konstanz, Konstanz, Germany)

This paper analyzes optimal hedging of a tradable risk (e.g. price risk or exchange rate risk) with forward contracts in the presence of untradable inflation risk. Utility is defined over real wealth. Optimal forward positions are derived relative to a given initial exposure in the tradable risk. A nominally unbiased forward market usually implies a non-zero real risk premium and hence some risk taking. If untradable inflation risk is a monotone function of the tradable risk plus noise, cross hedging and speculating on the real risk premium are conflicting objectives; the level of relative risk aversion determines which objective is dominant in a nominally unbiased forward market.

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Year of publication:	1999 ; This version: May 25, 1999
Authors:	Adam-Müller, Axel F. A.
Publisher:	[Konstanz] : [Zentrum für Finanzen und Ökonometrie, Universität Konstanz]
Subject:	hedging \| forward market \| untradable inflation risk \| relative risk aversion \| Derivat \| Derivative \| Hedging \| Inflation \| Portfolio-Management \| Portfolio selection \| Erwartungsnutzen \| Expected utility \| Theorie \| Theory \| Entscheidung unter Risiko \| Decision under risk