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A Bayesian Approach to Optimal Cross-Hedging of Cottonseed Products Using Soybean Complex Futures

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Author Info

  • Rahman, Shaikh Mahfuzur
  • Dorfman, Jeffrey H.
  • Turner, Steven C.
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    Abstract

    Cottonseed crushers face substantial risk in terms of input and output price variability and they are limited in their planning by the lack of a viable futures contract for cottonseed or cottonseed products. This study examines the feasibility of cross-hedging cottonseed products using the soybean complex futures. Different cross-hedging strategies are evaluated for eight time horizons relative to the expected profit and utility of the crusher. A Bayesian approach is employed to estimate both model parameters and optimal hedge ratios, allowing consistency with expected utility maximization in the presence of estimation risk. The results reveal that both whole cottonseed and cottonseed products can be successfully cross-hedged using soybean complex futures. The profitability of cross-hedging cottonseed products depends on the size of the contract, the optimal choice of strategy, the time of hedge placement, and the hedging horizon.

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    File URL: http://purl.umn.edu/31114
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    Bibliographic Info

    Article provided by Western Agricultural Economics Association in its journal Journal of Agricultural and Resource Economics.

    Volume (Year): 29 (2004)
    Issue (Month): 02 (August)
    Pages:

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    Handle: RePEc:ags:jlaare:31114

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    Web page: http://waeaonline.org/
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    Related research

    Keywords: Bayesian decision science; cottonseed; cross-hedging; risk management; Crop Production/Industries;

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    1. Klein, Roger W, et al, 1978. "Decisions with Estimation Uncertainty," Econometrica, Econometric Society, vol. 46(6), pages 1363-87, November.
    2. Lee, Jung-Hee & Brorsen, B. Wade, 1994. "Effect Of Risk Aversion On Feeder Cattle Prices," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 26(02), December.
    3. Lence, Sergio H & Hayes, Dermot J, 1994. " Parameter-Based Decision Making under Estimation Risk: An Application to Futures Trading," Journal of Finance, American Finance Association, vol. 49(1), pages 345-57, March.
    4. Babcock, Bruce A. & Choi, E. Kwan & Feinerman, Eli, 1993. "Risk And Probability Premiums For Cara Utility Functions," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 18(01), July.
    5. DeJong, David N. & Whiteman, Charles H., 1991. "Reconsidering 'trends and random walks in macroeconomic time series'," Journal of Monetary Economics, Elsevier, vol. 28(2), pages 221-254, October.
    6. Anderson, Ronald W & Danthine, Jean-Pierre, 1981. "Cross Hedging," Journal of Political Economy, University of Chicago Press, vol. 89(6), pages 1182-96, December.
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