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Financial instruments to hedge commodity price risk for developing countries


  • Lu, Yinqiu

    () (International Monetary Fund)

  • Neftci, Salih


Many developing economies are heavily exposed to commodity markets, leaving them vulnerable to the vagaries of international commodity prices. This paper examines the use of commodity options, including plain vanilla, risk reversal, and barrier options, to hedge such risks. It then proposes the use of a new structured product, a sovereign Eurobond with an embedded option on a specific commodity price. By extracting commodity price risk out of the bond, such an instrument insulates the bond default risk from commodity price movements, allowing it to be marketed at a lower credit spread. The product is also designed to help developing countries establish a credit derivatives market, which would in turn enhance the marketability and liquidity of sovereign bonds.

Suggested Citation

  • Lu, Yinqiu & Neftci, Salih, 2008. "Financial instruments to hedge commodity price risk for developing countries," Journal of Financial Transformation, Capco Institute, vol. 24, pages 137-143.
  • Handle: RePEc:ris:jofitr:0820

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    References listed on IDEAS

    1. Paolo Mauro & Torbjorn I. Becker & Jonathan David Ostry & Romain Ranciere & Olivier D Jeanne, 2007. "Country Insurance; The Role of Domestic Policies," IMF Occasional Papers 254, International Monetary Fund.
    2. Joseph Atta-Mensah, 2004. "Commodity-Linked Bonds: A Potential Means for Less-Developed Countries to Raise Foreign Capital," Staff Working Papers 04-20, Bank of Canada.
    3. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    4. Larson, Donald F. & Varangis, Panos & Yabuki, Nanae, 1998. "Commodity risk management and development," Policy Research Working Paper Series 1963, The World Bank.
    5. repec:rus:hseeco:74540 is not listed on IDEAS
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    Cited by:

    1. Byrne, Joseph P. & Fazio, Giorgio & Fiess, Norbert, 2013. "Primary commodity prices: Co-movements, common factors and fundamentals," Journal of Development Economics, Elsevier, vol. 101(C), pages 16-26.
    2. Byrne, Joseph P & Lorusso, Marco & Xu, Bing, 2017. "Oil Prices and Informational Frictions: The Time-Varying Impact of Fundamentals and Expectations," MPRA Paper 80668, University Library of Munich, Germany.

    More about this item


    Developing economies commodity risk; options; debt instrument; credit default swaps;

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets


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