Suboptimal options lead to significant economic loss in corporate hedging.
The article explores the best way for companies to protect themselves using options, considering production and basis risks. The researchers discovered that the exercise price that minimizes losses in a hedged portfolio is mainly influenced by how much money is spent on hedging. They also found that production risk affects how well hedging works, while basis risk determines the best type of contract to use. By simulating a financial crisis, they confirmed that choosing the wrong option type can result in significant financial losses.
