The impact of skewness in the hedging decision

Abstract

The impact of skewness in the hedger's objective function is tested using a model of hedging derived from a third-order Taylor Series approximation of expected utility. To determine the effect of price skewness upon hedging and speculation, analytical results are derived using an example of cotton storage. Findings suggest that when forward risk premiums and price skewness in the spot asset have opposite signs, speculation increases relative to the mean-variance model. When the signs are identical, speculation will decrease, contradicting findings of mean-variance models.

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“…Genton (2004) collects many useful and relevant articles on this subject. Overall, the skew-normal 1 Gilbert, Jones, and Morris (2006) incorporate the preference for skewness into the utility function to analyze the effect of skewness on the optimal hedge strategy.…”