Futures Hedge And Market Equilibrium Under Risk Aversion And Disappointment Aversion

From year 2002, Chinese Futures market recovered from a period of stagnancy and started to prosper with rocketing trading volume and enriching categories. It also gained more attention from the researchers. This paper is just trying to analyze the future market from a behavioral finance perspective. Specifically, we discussed the effect of risk aversion and disappointment aversion on optimal futures hedge strategy and futures market equilibrium.On the grounds of Behavioral Finance theories and relevant researches and literatures, our discussion integrates Gul's (1991) disappointment aversion framework with agent with Constant Absolute Risk Aversion in the first part this paper, and leads to the following conclusion on a risk and disappointment averse investor: in a backward market, the optimal hedge position is smaller than the optimal position of a mean—variance investor; in a contango market, the optimal hedge position is larger than the optimal position of a mean—variance investor. Increasing risk aversion and disappointment aversion have similar effects on optimal hedge position: increasing it in a backward market and decreasing it in a contango market. And one factor's effect is larger when the other factor gets smaller. Moreover, it shows that when investor is more disappointment averse, the reference point will be adjusted downward. The empirical analysis on data of soybean futures confirms above conclusions.The second part of this paper applies disappointment aversion to general futures market equilibrium framework, under the assumption there are only one producer and one speculator in the futures market. The comparative static analysis leads to the conclusion that the equilibrium trading volume is positively related to the producer's risk or disappointment aversion, and negatively related to the speculator's risk or disappointment aversion. When either agent's risk or disappointment aversion or the price volatility increases, the equilibrium price will decrease and producer's reference point will be lower. However when the producer gets more risk or disappointment averse, or price volatility increases, speculator's reference point tends to be higher.Under the framework of this paper, the above research results show that suchpsychological factors as risk aversion and disappointment aversion have explicit effects on futures hedge and market equilibrium. Thus it is proved that behavioral finance theory is a meaningful approach to futures market research.