How to Hedge if the Payment Date is Uncertain

Abstract

This paper studies the hedging of price risk if the payment date is uncertain, a problem that frequently occurs in practice. It derives and establishes the variance-minimizing hedging strategy, using forward contracts with different times to maturity. The resulting strategy fully hedges the expected price exposure for each possible payment date and is therefore easy to implement. An empirical study compares the performance of the variance-minimizing strategy with heuristic alternatives, using commodity prices and exchange rates. Our analysis shows that the variance-minimizing strategy clearly outperforms all the alternatives.