A utility based approach to energy hedging

A key issue in the estimation of energy hedges is the hedgers' attitude towards risk which is encapsulated in the form of the hedgers' utility function. However, the literature typically uses only one form of utility function such as the quadratic when estimating hedges. This paper addresses this issue by estimating and applying energy market based risk aversion to commonly applied utility functions including log, exponential and quadratic, and we incorporate these in our hedging frameworks. We find significant differences in the optimal hedge strategies based on the utility function chosen.

► This paper incorporates risk aversion in energy hedging. ► We compare and estimate hedges based on alternative utility functions. ► We examine quadratic, log and exponential utility. ► Significant differences exist for optimal hedges based on the utility function.