Modelling Optimal Hedge Ratio In The Presence Of Funding Risk

In the broad literature of corporate risk management classic models of optimal hedging assume a one-period hedging decision, and therefore no financing need arises to maintain the hedge position. The multi-period models are usually based on the assumption of no liquidity constraints, and accordingly the eventual financing need can always be met from the market. As a consequence of the recent crisis even interbank deals need to be collateralized, so the funding need of any financial transactions can be disregarded. Another usual assumption of the financial models refers to a zero expected value of the hedging position, which contradicts the also the practice. This study investigates the optimal hedge position as a function of 3 factors that determine the corporate utility function: the risk aversion ratio of the company, the expected value of the hedge position and the financing costs deriving from the hedging itself.