• Working Paper

    • Why Do Hedgers Hedge? The Role of Ambiguity

      Abstract: This study examines how ambiguity affects hedging behaviour in commodity futures markets. While the traditional literature suggests that hedging is primarily used to mitigate risk, experimental research indicates that individuals also exhibit a tendency to avoid ambiguity. I quantify ambiguity based on perturbations in uncertain probabilities and identify the effect of an ambiguity shock on hedging behaviour using impulse response functions from local projections. My research supports classical hedging theories in commodity markets, indicating a rise in hedging activity in uncertain conditions. The impact of ambiguity contrasts to the effect of risk while holding a comparable level of economic significance. Further, I find heterogeneity across different hedger sub-categories: Swap dealers react averse to ambiguity shocks and increase hedging demand whereas the activity of commodity producers is reduced. Swap dealers take risks for a risk premium, while producers hedge to manage risk. My findings contribute to the understanding of hedging behaviour and provide valuable insights for market participants and regulators.

      Available at SSRN