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The effects of option hedging on the costs of domestic price stabilization schemes

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  • Larson, Donald F.
  • Coleman, Jonathan

Abstract

Casual observation leads to the conclusion that stabilization funds tend to be short-lived. While it may be that some funds have failed due to poor management or unwarranted political interventions, the stochastic components of commodity prices can generate insurmountable difficulties for even the most expert managers. Price-band schemes contain an element of information feed-back and offer transparent rules -- attributes which make such schemes preferable to many alternative mechanisms -- but the benefits to producers tend to be, on average, quite small. Similar average benefits can be generated with very small import taxes or producer subsidies. Nevertheless, such schemes can have large single-year effects. The simulation results demonstrate that, if adopted, such funds should be hedged unless the government is not at all adverse to the fund's financial failure. Still, hedged or unhedged, such funds will, with eventual certainty, generate large levels of debt as a statistically"rare"sequence of events must eventually occur. By hedging, the funds are more likely to survive in the short-run.

Suggested Citation

  • Larson, Donald F. & Coleman, Jonathan, 1991. "The effects of option hedging on the costs of domestic price stabilization schemes," Policy Research Working Paper Series 653, The World Bank.
  • Handle: RePEc:wbk:wbrwps:653
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    References listed on IDEAS

    as
    1. Wright, Brian D. & Williams, Jeffrey C., 1990. "The Behavior of Markets for Storable Commodities," 1990 Conference (34th), February 13-15, 1990, Brisbane, Australia 145482, Australian Agricultural and Resource Economics Society.
    2. Coleman, Jonathan R.*Larson, Donald F., 1991. "Tariff-based commodity price stabilization schemes in Venezuela," Policy Research Working Paper Series 611, The World Bank.
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    Cited by:

    1. Donald F. Larson & Julian Lampietti & Christophe Gouel & Carlo Cafiero & John Roberts, 2014. "Food Security and Storage in the Middle East and North Africa," World Bank Economic Review, World Bank Group, vol. 28(1), pages 48-73.
    2. Larson, Donald F. & Varangis, Panos & Yabuki, Nanae, 1998. "Commodity risk management and development," Policy Research Working Paper Series 1963, The World Bank.
    3. Claessens, Stijn & Varangis, Panos & DEC, 1994. "Oil price instability, hedging, and an oil stabilization fund : the case of Venezuela," Policy Research Working Paper Series 1290, The World Bank.
    4. Duncan, Ron, 1995. "Managing Commodity Price Instability in Newly Liberalised Economies," 1995 Conference (39th), February 14-16, 1995, Perth, Australia 148800, Australian Agricultural and Resource Economics Society.
    5. Varangis, Panos & Larson, Don, 1996. "Dealing with commodity price uncertainty," Policy Research Working Paper Series 1667, The World Bank.

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