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The Impact of Price-Induced Hedging Behavior on Commodity Market Volatility

  • Kauffman, Nathan S.
  • Hayes, Dermot J.

The utility maximization problem of a grain producer is formulated and solved numerically under prospect theory as an alternative to expected utility theory. Conventional theory posits that the optimal hedging position of a producer is not affected solely due to changes in the level of futures prices. However, a strong degree of positive correlation is apparent in the data. Our results show that with prospect theory serving as the underlying behavioral framework, the optimal hedge of a producer is affected by changes in futures price levels. The implications of this price-induced hedging behavior on spot prices and volatility are subsequently considered.

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File URL: http://purl.umn.edu/103242
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Paper provided by Agricultural and Applied Economics Association in its series 2011 Annual Meeting, July 24-26, 2011, Pittsburgh, Pennsylvania with number 103242.

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Date of creation: 2011
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Handle: RePEc:ags:aaea11:103242
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