Optimal Hedging Under Forward-Looking Behavior

Lence, Sergio H.; Hayes, Dermot J.

Economic Record Vol. 71 no. 4 (December 1995): 329-342.

The production and hedging behavior of forward-looking risk-averse competitive firms is studied. It is shown that there is separation between production and hedging. Optimal production for a forward-looking firm is identical to that of an otherwise equivalent myopic firm. However, the optimal forward-looking hedge differs from the optimal myopic hedge. If forward prices are unbiased, full hedging is suboptimal when the firm is forward looking and output and material input prices are contemporaneously related. Furthermore, under certain conditions, the optimal forward-looking hedge under unbiased forward prices is strictly smaller than the full hedge.