Hedging Criteria: An Experimental Study on Minimum Variance vs. Lower Partial Moment Approaches

Last registered on April 23, 2025
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Pre-Trial

Trial Information

General Information

Title
Hedging Criteria: An Experimental Study on Minimum Variance vs. Lower Partial Moment Approaches
RCT ID
AEARCTR-0014675
Initial registration date
April 17, 2025

Initial registration date is when the trial was registered.

It corresponds to when the registration was submitted to the Registry to be reviewed for publication.

First published
April 23, 2025, 10:19 AM EDT

First published corresponds to when the trial was first made public on the Registry after being reviewed.

Locations

Country
United States of America
Region
Texas

Primary Investigator

Name
Siun Lee
Affiliation
Contact Primary Investigator

Other Primary Investigator(s)

PI Name
Paul Feldman
PI Affiliation
Contact Investigator

Additional Trial Information

Status
Completed
Start date
2024-09-02
End date
2024-12-31
Keywords
Behavior, Finance & Microfinance, Lab
Additional Keywords
JEL code(s)
Secondary IDs
Prior work
This trial does not extend or rely on any prior RCTs.
Abstract
This study investigates whether investors’ hedging behaviors align more closely with the traditional minimum variance (MV) approach or the second-order lower partial moment ($LPM_2$) criterion. Using a scenario-based design that differentiates MV and $LPM_2$ hedge ratios, participants allocated assets between two correlated lotteries representing spot and futures prices. The results reveal a divergence in hedge ratios, with some participants favoring $LPM_2$ due to its focus on downside risk rather than treating upside and downside risk equally, as MV does. This suggests that MV may underestimate risk aversion in scenarios involving asymmetric risk profiles. Notably, $LPM_2$ hedge ratios likely align more closely with participant decisions, particularly in situations where managing downside risk is prioritized over variance minimization. These findings bridge the gap between normative hedging theories and observed behaviors, offering insights for refining risk models and enhancing portfolio management strategies.
External Link(s)

Registration Citation

Citation
Feldman, Paul and Siun Lee. 2025. "Hedging Criteria: An Experimental Study on Minimum Variance vs. Lower Partial Moment Approaches." AEA RCT Registry. April 23. https://doi.org/10.1257/rct.14675-1.0
Sponsors & Partners
Experimental Details

Interventions

Intervention(s)
Intervention (Hidden)
Intervention Start Date
2024-11-04
Intervention End Date
2024-11-29

Primary Outcomes

Primary Outcomes (end points)
Subjects are presented with these lottery scenarios sequentially at a random order. For each scenario, subjects make their allocation decision between L1 and L2. We compare this subject's choice of alpha with calculated hedge ratios from the MV and LPM2 models to assess which theory better predicts the subjects' choices. This ratio is of particular interest as it quantifies the extent of hedging behavior. Note that alpha= 1 implies no hedging (all assets allocated to L1). As alpha decreases, the hedge ratio increases, more assets are allocated to L2 (increased hedging) indicating more aggressive hedging.
Primary Outcomes (explanation)

Secondary Outcomes

Secondary Outcomes (end points)
Secondary Outcomes (explanation)

Experimental Design

Experimental Design
Participants decide asset allocation between two correlated lotteries with 45 rounds. This design aims to compare the predictive power of two theoretical models: the minimum variance (MV) approach and the Lower Partial Moment (LPM_2) approach.
The experiment consists of two lotteries, L1 and L2, each with two possible outcomes. These lotteries are designed to reflect the relationship between spot and futures prices in financial markets. The outcomes represent the changes in spot and futures prices.

A key feature of this design is the perfect negative correlation (-1) between the two lotteries. This means with probability p, L1 yields a positive outcome while L2 yields a negative outcome. By the same token, with probability (1-p), L1 yields a negative outcome while L2 yields a positive outcome. This correlation structure is crucial because it accurately reflects the high correlation typically observed between spot and futures prices in financial markets. Also, it ensures a positive hedge ratio, which is consistent with real-world hedging strategies.
Experimental Design Details
Randomization Method
randomization done in office by a computer
Randomization Unit
randomization done in office by a computer
Was the treatment clustered?
No

Experiment Characteristics

Sample size: planned number of clusters
5 experimental scenarios
Sample size: planned number of observations
180 participants
Sample size (or number of clusters) by treatment arms
180 participants
Minimum detectable effect size for main outcomes (accounting for sample design and clustering)
Supporting Documents and Materials
IRB

Institutional Review Boards (IRBs)

IRB Name
IRB - TAMU CS
IRB Approval Date
2024-08-22
IRB Approval Number
STUDY2024-0861
Analysis Plan

Post-Trial

Post Trial Information

Study Withdrawal

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Intervention

Is the intervention completed?
No
Data Collection Complete
Data Publication

Data Publication

Is public data available?
No

Program Files

Program Files
Reports, Papers & Other Materials

Relevant Paper(s)

Reports & Other Materials