Abstract
There is anecdotal evidence of hedgers taking speculative positions using futures contracts—so-called “Texas hedges”—but the literature provides little guidance on this phenomenon. The paper explores the conditions under which “Texas hedges” may be optimal within the standard risk management framework. Using an empirical setting of multi-commodity hedging, we find that (1) “Texas hedges” do not occur when hedges are optimized individually (single-commodity hedging), (2) neither do they occur when the hedger's objective is to minimize variance, but (3) they do occur 18% of the time in a multi-commodity framework under a downside risk minimization objective (i.e., LPM2), which is closer to what hedgers actually do. Furthermore, (4) “Texas hedges” arise following periods of strong price momentum. This can be explained by downside risk-averse hedgers being concerned only about one side of the distribution. Therefore, expected favorable price movements are not treated as risk, but rather as a profit-enhancing opportunity.
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