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Futures Hedging Under Price, Basis and Production Risk

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Author Info
Lapan, Harvey E.
Moschini, Giancarlo

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Abstract

We consider the hedging problem of a firm that has three sources of risk: price, basis, and yield uncertainty. An exact solution for the optimal futures hesge is derived under the assumption that the three random variables are joint normally distributed and that utility is of the CARA type. Unlike the mean-variance approximation applied in previous research, we show that the optimal hedge does depend on risk attitudes, even when the agent perceives the futures price as being unbiased. The theoretical results are applied empirically to the problem of hedging soybean production in Iowa. The exact solution, relying on CARA and normality, is compared with numerical solutions under lognormal distributions and CRRA utility.

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Publisher Info
Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 10041.

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Date of creation: 20 Sep 2002
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Publication status: Published in American Journal of Agricultural Economics, August 1994, Vol. 76, No. 3, pp. 465-477.
Handle: RePEc:isu:genres:10041

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Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
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  1. Moawia Alghalith, 2006. "Hedging under price and output uncertainty: revisited," Applied Financial Economics Letters, Taylor and Francis Journals, vol. 2(4), pages 243-245, July. [Downloadable!] (restricted)
  2. Brovold, Karen & Qasmi, Bashir A., 1997. "Soybean Hedge Ratios for Eastern South Dakota Producers Facing Production and Price Uncertainty," 1997 Annual Meeting, July 13-16, 1997, Reno\Sparks, Nevada 35920, Western Agricultural Economics Association. [Downloadable!]
  3. Frechette, Darren L., 2000. "Hedging With Futures And Options: A Demand Systems Approach," 2000 Conference, April 17-18 2000, Chicago, Illinois 18941, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management. [Downloadable!]
  4. Joost M.E. Pennings & Raymond M. Leuthold, 1999. "Futures Exchange Innovations: Reinforcement versus Cannibalism," Finance 9905003, EconWPA. [Downloadable!]
  5. Haigh, Michael S. & Holt, Matthew T., 1999. "Volatility Spillovers Between Foreign Exchange, Commodity And Freight Futures Prices: Implications For Hedging Strategies," 1999 Annual meeting, August 8-11, Nashville, TN 21625, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association). [Downloadable!]
    Other versions:
  6. Tomek, William G. & Peterson, Hikaru Hanawa, 2000. "Risk Management In Agricultural Markets: A Survey," 2000 Producer marketing and Risk Management Conference, January 13-14, Orlando, FL 19580, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association). [Downloadable!]
  7. Moawia Alghalith, 2006. "Price and output risk: empirical analysis," Applied Economics Letters, Taylor and Francis Journals, vol. 13(6), pages 391-393, May. [Downloadable!] (restricted)
  8. Axel F. A. Adam-Müller & Kit Pong Wong, 2002. "Restricted Export Flexibility and Risk Management with Options and Futures," CoFE Discussion Paper 02-07, Center of Finance and Econometrics, University of Konstanz. [Downloadable!]
  9. repec:mop:credwp:04.12.53 is not listed on IDEAS
  10. Andreas Röthig, 2008. "The Impact of Backwardation on Hedgers' Demand for Currency Futures Contracts: Theory versus Empirical Evidence," Darmstadt Discussion Papers in Economics 190, Institut für Volkswirtschaftslehre (Department of Economics), Technische Universität Darmstadt (Darmstadt University of Technology). [Downloadable!]
  11. Moavia Alghalith & Aredishir J. Dalal, 2002. "The Choice Between Multiplicative and Additive Output Uncertainty," CRIEFF Discussion Papers 0209, Centre for Research into Industry, Enterprise, Finance and the Firm. [Downloadable!]
  12. Simmons, Phil, 1999. "Does Separation Theorem Explain Why Farmers Have So Little Interest In Futures Markets?," Working Papers 12933, University of New England, School of Economics. [Downloadable!]
  13. Moavia Alghalith, 2003. "Empirical Analysis under Additive/Multiplicative Output Uncertainty," CRIEFF Discussion Papers 0301, Centre for Research into Industry, Enterprise, Finance and the Firm. [Downloadable!]
    Other versions:
  14. Pannell, David & Hailu, Getu & Weersink, Alfons & Burt, Amanda, 2007. "More Reasons Why Farmers Have So Little Interest in Futures Markets," Working Papers 9232, University of Western Australia, School of Agricultural and Resource Economics. [Downloadable!]
    Other versions:
  15. Frechette, Darren & Delavan, Willard, 1998. "El Nino And Coffee Price Volatility In 1997," 1998 Annual meeting, August 2-5, Salt Lake City, UT 20908, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association). [Downloadable!]
  16. Benoît Sévi, 2006. "Ederington's ratio with production flexibility," Economics Bulletin, Economics Bulletin, vol. 7(1), pages 1-8. [Downloadable!]
  17. Moavia Alghalith, 2003. "Estimation and Econometric Tests Under Simultaneous Price and Output Uncertainty," CRIEFF Discussion Papers 0302, Centre for Research into Industry, Enterprise, Finance and the Firm. [Downloadable!]
  18. 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!]
  19. Wojciechowski, Jan & Ames, Glenn C.W. & Turner, Steven C. & Miller, Bill R., 1999. "Marketing Of Cotton Fiber In The Presence Of Yield And Price Risk," Faculty Series 16685, University of Georgia, Department of Agricultural and Applied Economics. [Downloadable!]
    Other versions:
  20. 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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