Optimal Hedging With Higher Moments

This study proposes a utility-based framework for the determination of optimal hedge ratios that can allow for the impact of higher moments on hedging decisions. We examine the entire hyperbolic absolute risk aversion (HARA) family of utilities which include quadratic, logarithmic, power and exponential utility functions. We find that for both moderate and large spot (commodity) exposures, the performance of out-of-sample hedges constructed allowing for non-zero higher moments is better than the performance of the simpler OLS hedge ratio. A revisited version of this paper was published in the October 2012 issue of the Journal of Futures Markets.