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Abstract

We analyze how the introduction of probability distortion and loss aversion in the standard hedging problem changes the optimal hedge ratio. Based on simulated cash and futures prices for soybeans, our results indicate that the optimal hedge changes considerably when probability distortion is considered. However, the impact of loss aversion on hedging decisions appears to be small, and it diminishes as loss aversion increases. Our findings suggest that probability distortion is a major driving force in hedging decisions, while loss aversion plays just a marginal role.

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