Hedging Long-term Commodity Risk With Dynamic Hedging Strategy

This essay focuses on the problem of hedging a long-term commitment to deliver a fixed amount of commodity, which often arises when the maturity of actively trading futures contracts on this commodity is limited to a few months. Problem is given and illustrated by real-world examples. Different hedging strategies are introduced. Finally, three stochastic pricing models proposed by Schwartz [17] and Cortazar and Schwartz [7] are discussed in detail and a new way proposed by Lautier and Galli [12] to calibrate the models which takes into account the error associated with the hedge ratios is reviewed.