Cash Settlement of Lean Hog Futures Contracts Reexamined
AbstractIn 1997 the Chicago Mercantile Exchange replaced its live hog futures contract with a cash settlement mechanism based on a Lean Hog Index. Although cash settlement was expected to increase the use of the contract as a hedging tool, producers and packers are concerned that convergence between cash and futures prices is not occurring and that the volatility of the lean hog contract basis has increased in recent years. The purpose of the paper is to reexamine cash settlement of lean hog futures contracts as a hedging tool, focusing on basis behavior and management of basis risk. We also investigate alternative hedging instruments that take into account location differences between regional cash prices and the CME lean hog index. Our results indicate that basis has widened and its variability prior to expiration has increased in the cash settlement period. Nevertheless, there is no evidence that ex-ante basis risk has increased, suggesting that the ability to forecast basis prior to expiration has not decreased with cash settlement. Our findings indicate that a contract on a regional basis can reduce producer price risk and may increase market returns. The benefits of a regional basis appear to accrue from providing the producer with an opportunity to manage the variability in returns associated with both the price level and basis.
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Bibliographic InfoPaper provided by NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management in its series 2008 Conference, April 21-22, 2008, St. Louis, Missouri with number 37611.
Date of creation: 2008
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basis behavior; cash settlement; ex-ante basis risk; lean hogs futures contract; regional basis; Agricultural Finance;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-12-14 (All new papers)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Ditsch, Mark W. & Leuthold, Raymond M., 1996. "Evaluating The Hedging Potential Of The Lean Hog Futures Contract," ACE OFOR Reports 14769, University of Illinois at Urbana-Champaign, Department of Agricultural and Consumer Economics.
- Elam, Emmett W., 1988. "Estimated Hedging Risk With Cash Settlement Feeder Cattle Futures," Western Journal of Agricultural Economics, Western Agricultural Economics Association, vol. 13(01), July.
- Shroeder, Ted C. & Mintert, James R., 1988. "Hedging Feeder Steers And Heifers In The Cash-Settled Feeder Cattle Futures Market," Western Journal of Agricultural Economics, Western Agricultural Economics Association, vol. 13(02), December.
- Franken, Jason R.V. & Parcell, Joseph L. & Tonsor, Glynn T., 2011. "Impact of Mandatory Price Reporting on Hog Market Integration," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 43(02), May.
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