Determining the Effectiveness of Exchange Traded Funds as a Risk Management Tool for Southeastern Producers

This research investigates the use of commodity exchange traded funds (ETFs) as a price risk management tool for agriculture producers. The effectiveness of using ETFs to hedge price risk will be determined by calculating optimal hedge ratios. This paper will investigate the southeastern producer’s ability to hedge their price risk for not only outputs, like corn and feeder cattle, but also for inputs, like diesel fuel and fertilizer. These ratios will be calculated using ordinary least squares (OLS), error correction model (ECM), and generalized autoregressive conditional heteroskedasticity (GARCH) regression models. A utility maximization framework will be used to determine how transaction costs and risk aversion effect the optimal hedge ratio. Being able to use ETFs to hedge price risk would provide a significant tool to small and mid-sized producers who are unable to take advantage of current price risk management practices, such as the use of futures, because of the large size of the futures contracts. ETFs also present a potential tool to manage a producer’s input price risk. A majority of producers are unable to protect themselves from the rising costs of inputs due to producers’ small production size and unavailability of protection methods.