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

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  • Moschini, GianCarlo
  • Lapan, Harvey E.

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 CARA (constant absolute risk aversion) utility and normal distributions, we 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.

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Bibliographic Info

Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 5137.

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Date of creation: 01 Nov 1995
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Publication status: Published in International Economic Review, November 1995, vol. 36 no. 4, pp. 1025-1049
Handle: RePEc:isu:genres:5137

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Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
Phone: +1 515.294.6741
Fax: +1 515.294.0221
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Web page: http://www.econ.iastate.edu
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Cited by:
  1. Wong, Kit Pong, 2003. "Currency hedging with options and futures," European Economic Review, Elsevier, Elsevier, vol. 47(5), pages 833-839, October.
  2. Guy MEUNIER, 2013. "Risk aversion and technology mix in an electricity market," Working Papers 221660, Institut National de la Recherche Agronomique, France.
  3. Hennessy, David A., 1998. "Risk Market Innovations and Choice," International Review of Economics & Finance, Elsevier, Elsevier, vol. 7(3), pages 331-341.
  4. Moschini, GianCarlo & Myers, Robert J., 2002. "Testing for constant hedge ratios in commodity markets: a multivariate GARCH approach," Journal of Empirical Finance, Elsevier, Elsevier, vol. 9(5), pages 589-603, December.
  5. Brown, Gregory W., 2001. "Managing foreign exchange risk with derivatives," Journal of Financial Economics, Elsevier, Elsevier, vol. 60(2-3), pages 401-448, May.
  6. Lalancette, Simon & Leclerc, Frank & Turcotte, David, 2004. "Selective hedging with market views and risk limits: the case of Hydro-Quebec," The Quarterly Review of Economics and Finance, Elsevier, Elsevier, vol. 44(5), pages 710-726, December.
  7. Benninga, Simon Z. & Oosterhof, Casper M., 2004. "Hedging with forwards and puts in complete and incomplete markets," Journal of Banking & Finance, Elsevier, Elsevier, vol. 28(1), pages 1-17, January.
  8. Lien, Donald & Wong, Kit Pong, 2004. "Optimal bidding and hedging in international markets," Journal of International Money and Finance, Elsevier, Elsevier, vol. 23(5), pages 785-798, September.
  9. Battermann, Harald L. & Braulke, Michael & Broll, Udo & Schimmelpfennig, Jorg, 2000. "The preferred hedge instrument," Economics Letters, Elsevier, Elsevier, vol. 66(1), pages 85-91, January.
  10. Adam, Tim, 2009. "Capital expenditures, financial constraints, and the use of options," Journal of Financial Economics, Elsevier, Elsevier, vol. 92(2), pages 238-251, May.
  11. de Janvry, A. & Dequiedt, V. & Sadoulet, E., 2014. "The demand for insurance against common shocks," Journal of Development Economics, Elsevier, Elsevier, vol. 106(C), pages 227-238.
  12. 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., Escuela de Administracion. Pontificia Universidad Católica de Chile., vol. 8(2), pages 88-110.
  13. Adam, Tim Rene, 2002. "Risk management and the credit risk premium," Journal of Banking & Finance, Elsevier, Elsevier, vol. 26(2-3), pages 243-269, March.
  14. Coble, Keith H. & Zuniga, Manuel & Heifner, Richard, 2003. "Evaluation of the interaction of risk management tools for cotton and soybeans," Agricultural Systems, Elsevier, Elsevier, vol. 75(2-3), pages 323-340.
  15. Mohamed Mnasri & Georges Dionne & Jean-Pierre Gueyie, 2013. "The Maturity Structure of Corporate Hedging: the Case of the U.S. Oil and Gas Industry," Cahiers de recherche, CIRPEE 1337, CIRPEE.

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