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Volatility Spillovers Between Foreign Exchange, Commodity And Freight Futures Prices: Implications For Hedging Strategies

  • Haigh, Michael S.
  • Holt, Matthew T.

In many studies the assumption is made that traders only encounter one type of price risk. In reality, however, traders are exposed to multiple price risks, and often have several relevant derivative instruments available with which to hedge price uncertainty. In this study, commodity, foreign exchange, and freight futures contracts are analyzed for their effectiveness in reducing price uncertainty for international grain traders. A theoretical model is developed for a representative European importer to depict a realistic trading problem encountered by an international grain trading corporation exposed to more than one type of price risk. The traditional method of estimating hedge ratios by Ordinary Least Squares (OLS) is compared to the Seemingly Unrelated Regression (SUR) and the multivariate GARCH (MGARCH) methodology, which takes into account time-varying variances and covariances between the cash and futures markets. Explicit modeling of the time-variation in futures hedge ratios via the MGARCH methodology, using all derivatives and taking into account dependencies between markets results in a significant reduction in price risk for grain traders. The results also confirm that the unique, but underutilized, freight futures market is a potentially useful mechanism for reducing price uncertainty for international grain traders. The research undertaken in this study provides valuable information about reducing price uncertainty for international grain traders and gives a better understanding of the linkages between closely related markets.

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File URL: http://purl.umn.edu/23997
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Paper provided by Texas A&M University, Department of Agricultural Economics in its series Faculty Paper Series with number 23997.

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Date of creation: 1999
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Handle: RePEc:ags:tamufp:23997
Contact details of provider: Postal: College Station, TX 77849-2124
Web page: http://agecon.tamu.edu/
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  1. Rausser, Gordon C. & Carter, Colin A., 1982. "Futures market efficiency in the soybean complex," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt7d48x9qc, Department of Agricultural & Resource Economics, UC Berkeley.
  2. Lapan, Harvey E. & Moschini, GianCarlo, 1994. "Futures Hedging Under Price, Basis and Production Risk," Staff General Research Papers 10041, Iowa State University, Department of Economics.
  3. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
  4. Lence, Sergio H., 1996. "Relaxing The Assumptions Of Minimum-Variance Hedging," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 21(01), July.
  5. Tomislav Vukina & Dong-feng Li & Duncan M. Holthausen, 1996. "Hedging with Crop Yield Futures: A Mean-Variance Analysis," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 78(4), pages 1015-1025.
  6. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
  7. Kroner, Kenneth F. & Claessens, Stijn, 1991. "Optimal dynamic hedging portfolios and the currency composition of external debt," Journal of International Money and Finance, Elsevier, vol. 10(1), pages 131-148, March.
  8. Kawai, Masahiro & Zilcha, Itzhak, 1986. "International trade with forward-futures markets under exchange rate and price uncertainty," Journal of International Economics, Elsevier, vol. 20(1-2), pages 83-98, February.
  9. Gagnon, Louis & Lypny, Gregory J. & McCurdy, Thomas H., 1998. "Hedging foreign currency portfolios," Journal of Empirical Finance, Elsevier, vol. 5(3), pages 197-220, September.
  10. Lence, Sergio H., 1995. "The Economic Value of Minimum-Variance Hedges," Staff General Research Papers 5053, Iowa State University, Department of Economics.
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