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The Hedging Role of Options and Futures under Joint Price, Basis, and Production Risk

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Author Info
Moschini, Giancarlo
Lapan, Harvey

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Abstract

This paper analyzes the optimal production and hedging decisions for firms facing futures price, basis, and production risk, assuming futures and options can be used. Using constant absolute risk aversion utility and normal distributions, the authors derive an exact solution and show that joint production and price risk lead to a hedging role for options. Risk averse firms that can use each hedging instrument will generally have higher (expected) output. Using Iowa data for soybeans, the parameters of the joint distribution of future prices, cash prices, and yields are estimated and the results are used to approximate optimal hedging decisions for soybean producers. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

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Publisher Info
Article provided by Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association in its journal International Economic Review.

Volume (Year): 36 (1995)
Issue (Month): 4 (November)
Pages: 1025-49
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Handle: RePEc:ier:iecrev:v:36:y:1995:i:4:p:1025-49

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  1. Ripplinger, David & Hayes, Dermot J. & Goggi, Susana & Lamkey, Kendall, 2008. "Insuring Against Losses from Transgenic Contamination: The Case of Pharmaceutical Maize," Staff General Research Papers 12957, Iowa State University, Department of Economics. [Downloadable!]
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  2. Moschini, GianCarlo & Myers, Robert J., 2001. "Testing for Constant Hedge Ratios in Commodity Markets: A Multivariate GARCH Approach," Staff General Research Papers 1945, Iowa State University, Department of Economics.
    Other versions:
  3. Axel F. A. Adam-Müller, 2001. "What to Do if Dollar is Not a Dollar? The Impact of Inflation Risk on Production and Risk Management," CoFE Discussion Paper 01-06, Center of Finance and Econometrics, University of Konstanz. [Downloadable!]
  4. Coble, Keith H. & Heifner, Richard G. & Zuniga, Manuel, 2000. "Implications Of Crop Yield And Revenue Insurance For Producer Hedging," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 25(02), December. [Downloadable!]
  5. Sarris, Alexander, 2002. "The demand for commodity insurance by developing country agricultural producers - theory and an application to cocoa in Ghana," Policy Research Working Paper Series 2887, The World Bank. [Downloadable!]
  6. Xiaodong Du & David A. Hennessy, 2008. "Planting Real Option in Cash Rent Valuation, The," Center for Agricultural and Rural Development (CARD) Publications 08-wp463, Center for Agricultural and Rural Development (CARD) at Iowa State University. [Downloadable!]
  7. Thilo Pausch, 2003. "Bank's Assets and Liabilities Management with Multiple Sources of Risk," Discussion Paper Series 245, Universitaet Augsburg, Institute for Economics. [Downloadable!]
  8. Augusto Castillo R. & Rafael Aguila, 2005. "Estrategias Optimas De Cobertura En Presencia De Incertidumbre En Costos Y Cantidad," Abante, Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 8(2), pages 88-110. [Downloadable!]
  9. Mahul, Olivier, 2002. "Hedging Price Risk In The Presence Of Crop Yield And Revenue Insurance," 2002 Conference, April 22-23, 2002, St. Louis, Missouri 19070, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management. [Downloadable!]
  10. Thilo Pausch, 2003. "The Lender-Borrower Relationship with Risk Averse Lenders," Discussion Paper Series 244, Universitaet Augsburg, Institute for Economics. [Downloadable!]
  11. Du, Xiaodong & Hennessy, David A., 2008. "The Planting Real Option in Cash Rent Valuation," Staff General Research Papers 12874, Iowa State University, Department of Economics. [Downloadable!]
  12. Kuwornu, John K.M. & Kuiper, W. Erno & Pennings, Joost M.E. & Meulenberg, Matthew T.G., 2006. "Risk Management Using Futures Contracts: The Impact of Spot Market Contracts and Production Horizons on the Optimal Hedge Ratio," 99th Seminar, February 8-10, 2006, Bonn, Germany 7755, European Association of Agricultural Economists. [Downloadable!]
  13. Mahul, Olivier, 2002. "Hedging Price Risk in the Presence of Crop Yield and Revenue Insurance," 2002 International Congress, August 28-31, 2002, Zaragoza, Spain 24881, European Association of Agricultural Economists. [Downloadable!]
  14. Mahul, Olivier & Vermersch, Dominique, 1999. "Hedging Crop Risk With Yield Insurance Futures And Options," 1999 Annual meeting, August 8-11, Nashville, TN 21672, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association). [Downloadable!]
  15. Coble, Keith H. & Barnett, Barry J., 1999. "The Role Of Research In Producer Risk Management," Professional Papers 15803, Mississippi State University, Department of Agricultural Economics. [Downloadable!]
  16. Wilson, William W. & Wagner, Robert & Nganje, William, 2003. "Strategic Hedging For Grain Processors," Agribusiness & Applied Economics Report 23637, North Dakota State University, Department of Agribusiness and Applied Economics. [Downloadable!]
  17. Xing, Liu & Pietola, Kyosti, 2005. "Forward Hedging Under Price and Production Risk of Wheat," 2005 International Congress, August 23-27, 2005, Copenhagen, Denmark 24467, European Association of Agricultural Economists. [Downloadable!]
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