Downside risk and the energy hedger's horizon

Abstract

In this paper, we explore the impact of investor time-horizon on an optimal downside hedged energy portfolio. The optimal heating oil hedge ratio is first calculated for a variety of downside risk objective functions at different time-horizons using the wavelet transform. Next, associated hedging effectiveness is contrasted for a range of risk metrics, with all metrics showing increasing hedging effectiveness at longer horizons. Moreover, decreased hedging effectiveness is demonstrated for increased levels of uncertainty at higher confidence intervals. While small differences in effectiveness are found across the different hedging objectives, time-horizon effects are found to dominate confirming the importance of the hedging horizon. The findings suggest that while downside risk measures are useful in determining an optimal futures hedge encompassing negative returns, hedging horizon and confidence intervals should also be given careful consideration by the energy hedger.