Title: Optimum short-term futures hedge using stochastic linear programming

Authors: Samuel Frimpong, Kwame Awuah-Offei, George Dogbe

Addresses: School of Materials, Energy and Earth Resources, University of Missouri-Rolla, 1870 Miner Circle, 226 McNutt Hall, Rolla, MO 65409, USA. ' School of Materials, Energy and Earth Resources, University of Missouri-Rolla, 1870 Miner Circle, 226 McNutt Hall, Rolla, MO 65409, USA. ' School of Mining and Petroleum Engineering, University of Alberta, 220 CEB, Edmonton, AB, T6G 2G7 Canada

Abstract: Classical optimal hedge ratio concentrates on risk reduction and neglects strategic value maximisation. In this study, the authors use stochastic optimisation theories to formulate an optimal, short-term hedging scheme to mitigate risks while maximising portfolio value. Stochastic spot and futures price models are used to simulate prices. The periodic optimal hedge ratios are determined using the stochastic-optimisation algorithm. The algorithm is implemented in a Hedge-Position-Optimiser (HPO) which is verified and validated using crude oil and gold data. The results show that HPO adds value to projects by increasing portfolio value while reducing the associated risks.

Keywords: optimal hedge ratio; stochastic optimisation; simulation; minerals industry; crude oil; gold; short-term futures; risk assessment; risk reduction; strategic value maximisation; spot price models; futures price models.

DOI: 10.1504/IJRAM.2007.014091

International Journal of Risk Assessment and Management, 2007 Vol.7 No.5, pp.639 - 655

Published online: 18 Jun 2007 *

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