Management Science and Financial Engineering

The Korean Operations Research and Management Science Society (한국경영과학회)
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Uncertainty, View, and Hedging: Optimal Choice of Instrument and Strike for Value Maximization

  • Kwon, Oh-Sang (Graduate School of Innovation and Technology Management, Korea Advanced Institute of Science and Technology)
  • Received : 2011.10.05
  • Accepted : 2011.10.30
  • Published : 2011.11.30
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Abstract

This paper analytically studies how to choose hedging instrument for firms with steady operating cash flows from value maximization perspective. I derive a formula to determine option's optimal strike that makes hedged cash flow have the best monetary payoff given a hedger's view on the underlying asset. I find that not only the expected mean but also the expected standard deviation of the underlying asset in relation to the forward price and the implied volatility play a crucial role in making optimal hedging decision. Higher moments play a certain part in hedging decision but to a lesser degree.

Keywords

References

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