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Time-varying hedge ratios in linked agricultural markets

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  • Anton Bekkerman

Abstract

Purpose – The purpose of this paper is to examine the potential gains in hedge ratio calculation for agricultural commodities by incorporating market linkages and prices of related commodities into the hedge ratio estimation process. Design/methodology/approach – A vector autoregressive multivariate generalized autoregressive conditional heteroskedasticity (VAR-MGARCH) model is used to construct a time-varying correlation matrix for commodity prices across linked markets and across linked commodities. The MGARCH model is estimated using a two-step approach, which allows for a large system of related prices to be estimated. Findings – In-sample and out-of-sample portfolio variance comparison among no hedge, bivariate GARCH, and MGARCH models indicates that hedge ratios estimated using the MGARCH approach reduce agricultural producers' and commercial consumers' risks in futures market participation. Research limitations/implications – The application is limited to an examination of Montana wheat markets. Practical implications – Agricultural producers who use futures markets to reduce market risk will have a better method for determining hedging positions, because MGARCH estimated hedge ratios incorporate more information than hedge ratios estimated using existing practices. Social implications – Portfolio variance reduction is analogous to utility improvement for agricultural producers. More efficient hedging strategies can lead to better implementation of futures markets and increased social welfare. Originality/value – This research substantially extends current literature on agricultural hedge strategies by illustrating the advantages of using an hedge ratio estimation approach that incorporates important information about prices at linked markets and prices of other commodities. Providing evidence that market portfolio variance can be lowered using the multivariate estimation approach, the research offers commercial agricultural producers and consumers a practical tool for improving futures market strategies.

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Bibliographic Info

Article provided by Emerald Group Publishing in its journal Agricultural Finance Review.

Volume (Year): 71 (2011)
Issue (Month): 2 (July)
Pages: 179-200

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Handle: RePEc:eme:afrpps:v:71:y:2011:i:2:p:179-200

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Related research

Keywords: Agriculture; Commodity types; GARCH-DCC; Linked markets; Time-varying hedge ratios; United States of America; Wheat;

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References

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  1. Choudhry, Taufiq, 2009. "Short-run deviations and time-varying hedge ratios: Evidence from agricultural futures markets," International Review of Financial Analysis, Elsevier, vol. 18(1-2), pages 58-65, March.
  2. Bollerslev, Tim & Engle, Robert F & Wooldridge, Jeffrey M, 1988. "A Capital Asset Pricing Model with Time-Varying Covariances," Journal of Political Economy, University of Chicago Press, vol. 96(1), pages 116-31, February.
  3. Shiqing Ling & Michael McAleer, 2001. "Asymptotic Theory for a Vector ARMA-GARCH Model," ISER Discussion Paper 0549, Institute of Social and Economic Research, Osaka University.
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  16. Lence, Sergio H., 1995. "On the Optimal Hedge Under Unbiased Futures Prices," Staff General Research Papers 5115, Iowa State University, Department of Economics.
  17. Kroner, Kenneth F. & Sultan, Jahangir, 1993. "Time-Varying Distributions and Dynamic Hedging with Foreign Currency Futures," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 28(04), pages 535-551, December.
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