Relaxing standard hedging assumptions in the presence of downside risk

We analyze how the introduction of a downside risk measure and less restrictive assumptions in the standard hedging problem changes the optimal hedge and the opportunity costs of not hedging. Based on a dataset of futures and cash returns for soybeans and S&P 500 returns, the findings indicate that the optimal hedge changes considerably when a one-sided risk measure is adopted and standard assumptions are relaxed. Further, the results suggest that in a downside risk framework with realistic hedging assumptions there is little or no incentive for producers to hedge as the opportunity cost of not hedging is small. (C) 2006 Board of Trustees of the University of Illinois. All rights reserved.