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The Impact of Price-Induced Hedging Behavior on Commodity Market Volatility

Author

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  • Kauffman, Nathan S.
  • Hayes, Dermot J.

Abstract

The utility maximization problem of a grain producer is formulated and solved numerically under prospect theory as an alternative to expected utility theory. Conventional theory posits that the optimal hedging position of a producer is not affected solely due to changes in the level of futures prices. However, a strong degree of positive correlation is apparent in the data. Our results show that with prospect theory serving as the underlying behavioral framework, the optimal hedge of a producer is affected by changes in futures price levels. The implications of this price-induced hedging behavior on spot prices and volatility are subsequently considered.

Suggested Citation

  • Kauffman, Nathan S. & Hayes, Dermot J., 2011. "The Impact of Price-Induced Hedging Behavior on Commodity Market Volatility," 2011 Annual Meeting, July 24-26, 2011, Pittsburgh, Pennsylvania 103242, Agricultural and Applied Economics Association.
    • Handle: RePEc:ags:aaea11:103242
    DOI: 10.22004/ag.econ.103242
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    Cited by:

    1. Jacobs, Keri & Li, Ziran & Hayes, Dermot, 2016. "Price Responses in Forward Contracting: Do We Limit The Upside And Expose The Downside?," ISU General Staff Papers 201601010800001017, Iowa State University, Department of Economics.
    2. Choe, Chongwoo & Lien, Donald & Yu, Chia-Feng (Jeffrey), 2015. "Optimal managerial hedging and contracting with self-esteem concerns," International Review of Economics & Finance, Elsevier, vol. 37(C), pages 354-367.

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    Keywords

    Agribusiness; Institutional and Behavioral Economics; Risk and Uncertainty;
    All these keywords.

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