The Effects of Hedging and Speculation on Cash-Futures Basis: Results from U.S. Wheat Markets

This study examines impacts of hedging and speculation shocks on cash-futures basis for three types of wheat produced in the Northwest U.S. Volatility transfers are measured using a Bayesian vector autoregression (BVAR) procedure to capture the contemporaneous effects of cashfutures basis and open interest positions. By applying a BVAR model and inducing stationarity with the Baxter-King filter this study observes aggregate position sizes relative to actual basis levels within an endogenous structural framework. The results demonstrate a pattern of significant impulse responses to basis from shocks to hedging and speculative total open interest for each market. Positive shocks to open interest create contemporaneous positive impacts on the basis and an increased convenience yield. This implies the risk premium nested within the basis also varies with shocks to hedging and speculative positions. Historical decompositions indicate that hedger and speculator total open interest explains short-run basis volatility for Chicago and Kansas City markets, but not for the Minneapolis market. Evidence is provided that the difference is due to lower liquidity levels in Minneapolis. The results imply that speculator provided liquidity benefits hedgers across the supply chain. This information is valuable to hedgers and liquidity providers, as well as producers, distributors, and exporters.