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Time‐varying hedge ratios in linked agricultural markets

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  • Anton Bekkerman

Abstract

Purpose - The purpose of this paper is to examine the potential gains in hedge ratio calculation for agricultural commodities by incorporating market linkages and prices of related commodities into the hedge ratio estimation process. Design/methodology/approach - A vector autoregressive multivariate generalized autoregressive conditional heteroskedasticity (VAR‐MGARCH) model is used to construct a time‐varying correlation matrix for commodity prices across linked markets and across linked commodities. The MGARCH model is estimated using a two‐step approach, which allows for a large system of related prices to be estimated. Findings - In‐sample and out‐of‐sample portfolio variance comparison among no hedge, bivariate GARCH, and MGARCH models indicates that hedge ratios estimated using the MGARCH approach reduce agricultural producers' and commercial consumers' risks in futures market participation. Research limitations/implications - The application is limited to an examination of Montana wheat markets. Practical implications - Agricultural producers who use futures markets to reduce market risk will have a better method for determining hedging positions, because MGARCH estimated hedge ratios incorporate more information than hedge ratios estimated using existing practices. Social implications - Portfolio variance reduction is analogous to utility improvement for agricultural producers. More efficient hedging strategies can lead to better implementation of futures markets and increased social welfare. Originality/value - This research substantially extends current literature on agricultural hedge strategies by illustrating the advantages of using an hedge ratio estimation approach that incorporates important information about prices at linked markets and prices of other commodities. Providing evidence that market portfolio variance can be lowered using the multivariate estimation approach, the research offers commercial agricultural producers and consumers a practical tool for improving futures market strategies.

Suggested Citation

  • Anton Bekkerman, 2011. "Time‐varying hedge ratios in linked agricultural markets," Agricultural Finance Review, Emerald Group Publishing Limited, vol. 71(2), pages 179-200, August.
    • Handle: RePEc:eme:afrpps:v:71:y:2011:i:2:p:179-200
    DOI: 10.1108/00021461111152564
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    References listed on IDEAS

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    Cited by:

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    2. Carlotta Penone & Elisa Giampietri & Samuele Trestini, 2021. "Hedging Effectiveness of Commodity Futures Contracts to Minimize Price Risk: Empirical Evidence from the Italian Field Crop Sector," Risks, MDPI, vol. 9(12), pages 1-14, December.
    3. Jędrzej Białkowski & Martin T. Bohl & Devmali Perera, 2022. "Commodity Futures Hedge Ratios: A Meta-Analysis," Working Papers in Economics 22/12, University of Canterbury, Department of Economics and Finance.
    4. Lu, Xinjie & Su, Yuandong & Huang, Dengshi, 2023. "Chinese agricultural futures volatility: New insights from potential domestic and global predictors," International Review of Financial Analysis, Elsevier, vol. 89(C).

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