Hedging Strategy and Electricity Contract Engineering - IFOR

5.4 Best Hedge 113
that they already face, whereas speculators wish to take a risky position in
the market in order to possibly make a profit. Arbitrageurs take advantage of
arbitrage opportunities to make riskless returns, but are of no importance in
this context. The difference between hedgers and speculators can however be
rather fine. A player that finds a best hedge, but with a very high constraint
on the expected profit, is he a hedger or a speculator? He knows that a high
constraint on the profit will result in a high risk, why one could view him
as a speculator. On the other hand, he is minimizing the risk and could also
be viewed as a hedger. Our notion of best hedge, where a constraint on the
expected profit is introduced therefore generalizes the notion of hedgers to
comprise also speculators. In the limit when the best hedge is found under
as high expected profit constraint as possible resulting in at least one feasible
portfolio, it naturally corresponds to a profit maximization without any concerns
on the risk level. A speculator could hence also be characterized by a
player that maximizes the expected profit with a soft constraint on the risk level.
The best hedge is actually a small scale portfolio optimization, where typically
only part of the whole portfolio is considered, namely the contract or contracts
that are to be hedged. In Chapter 6 we will introduce the power portfolio optimization,
where a similar optimization is used and where the whole portfolio
is considered. We will therefore not go into details on, for example, how the
production side is actually modeled here, but leave that for the next chapter.