An Economic Analysis of Risk Management Strategies for Alberta Beef Feeders

This study investigates slaughter price risk and risk management in finishing heavy feeder steers in a custom feedlot in Alberta. The base model uses a simulation based on historical data of a cattle investor buying and feeding 100 heavy feeder steers each month from 1980 to 1989 in a custom feedlot in Alberta. Several investment strategies are studied using this base model including hedging using in Chicago Mercantile Exchange (CME) live cattle futures contract, put options and participating in the National Tripartite Stabilization Program (NTSP). Risk is measured using deviations from forecast net returns (Mean Square Error) and the investment beta from the Capital Asset Pricing Model. The CME live cattle futures contract adjusted for exchange rate and local basis is used to forecast Alberta slaighter steer prices. Hedging 100% of expected production significantly reduces slaughter price risk. Over extended periods of time the cost of this strategy is not high. An Alberta cattle investor can get results similiar to 100% hedging by selling CME live cattle contracts equal to about 60% of the expected cattle production. Basis risk, a part of hedging risk, is lower for the period 1985-1989 than for 1976 to 1980. Basis risk for the Alberta cattle investor does not prevent the effective use of the CME live cattle contract for managing risk. Put options can be used as insurance against price drops. However 100% hedging may be as effective. Participation in the NTSP reduces risk slightly but not significantly, and increases net returns. The risk averse and risk neutral cattle investor benefits from particiapation in the NTSP. The returns in cattle feeding in Alberta are not highly correlated to the TSE 300. A large portion of cattle feeding risk can be diversified away by investing in the TSE 300.