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Why Grain Merchants Will Never Be So Naïve to Use Minimum Variance Hedging in Daily Business: a Critical Discussion

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  • Prehn, Soren

Abstract

Minimum variance hedging is probably one of the most popular concepts in the literature on agricultural futures markets. It has been applied many times in the literature, and all studies confirmed that minimum variance hedging has the potential to improve the effectiveness of hedging. However, despite this advantage, no grain merchant has ever used minimum variance hedging in daily business. In this paper we show that grain merchants have a good reason for this. Minimum variance hedging prevents them from trading the basis. If grain merchants do not trade the basis, they will not generate the profits that are necessary to cover the costs of grain storage and will go bankrupt sooner or later. In theory, risk avoidance may be a desirable goal, but in reality, it is not affordable. In fact, the only longterm sustainable strategy is basis trading.

Suggested Citation

  • Prehn, Soren, 2020. "Why Grain Merchants Will Never Be So Naïve to Use Minimum Variance Hedging in Daily Business: a Critical Discussion," 2020 Conference, St. Louis, Missouri 309644, NCR-134/ NCCC-134 Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    • Handle: RePEc:ags:nccc20:309644
    DOI: 10.22004/ag.econ.309644
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    References listed on IDEAS

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