New model revolutionizes hedging with options, reducing risk and cost.
The article presents a model for firms to hedge their spot positions using options, considering production and basis risks. The optimal hedge ratio is flexible, using a copula function to represent the dependence structure. The study shows that the exercise price minimizing risk is sensitive to certain parameters, with firm risk aversion not affecting the outcome. The main trade-off lies between the effectiveness and cost of the hedging strategy.