Hedging Multiple Price Uncertainty in International Grain Trade

Commodity and freight futures contracts are analyzed for their effectiveness in reducing uncertainty for international traders. A theoretical model is developed for a trader exposed to several types of risk. OLS hedge ratio estimation is compared to the SUR and the multivariate GARCH methodologies. Explicit modeling of the time-variation in hedge ratios via the multivariate GARCH methodology, using all derivatives, and taking into account dependencies between prices, results in reductions in risk, even after accounting for transaction costs. Results confirm that while the commodity futures contracts are important for hedging risk, freight futures are a useful mechanism for reducing risk.     

Hedging Opportunities for Canadian

The unprecedented commodity price volatility in the last decade has resulted in a growing interest in futures trading by farmers. One of the major reasons often provided for the usefulness of commodity futures markets is that they provide a mechanism whereby producers can shift the risk of price change onto others. Interestingly, little research has been conducted on the effectiveness of the WCE as a hedging tool for farmers.
The objective of this paper was to investigate the extent to which the futures contracts for rapeseed, barley and flaxseed can be used by farmers in order to reduce price risk (measured by volatility). Drawing on earlier literature, the theory of hedging was reviewed and formulae for estimating the optimal hedge and the effectiveness of hedging were presented. An empirical analysis determined that the Winnipeg rapeseed, barley and flaxseed futures contracts are very useful in terms of allowing a producer the opportunity to reduce exposure to price risk.     

Time‐varying Hedge Ratios: A Principal‐agent Approach

We use the classic agency model to derive a time‐varying optimal hedge ratio for low‐frequency time‐series data: the type of data used by crop farmers when deciding about production and about their hedging strategy. Rooted in the classic agency framework, the proposed hedge ratio reflects the context of both the crop farmer's decision and the crop farmer's contractual relationships in the marketing channel. An empirical illustration of the Dutch ware potato sector and its futures market in Amsterdam over the period 1971–2003 reveals that the time‐varying optimal hedge ratio decreased from 0.34 in 1971 to 0.24 in 2003. The hedging effectiveness, according to this ratio, is 39%. These estimates conform better with farmers’ interest in using futures contracts for hedging purposes than the much higher estimates obtained when price risk minimisation is the only objective considered.     

Risk Management for Grain Processors and “Copulas”

The importance of calibrating hedging strategies for processors has escalated primarily due to the sharply increased volatility of futures, product, and by‐product prices. The purpose of this paper is to analyze price risk‐management strategies for wheat flour milling using copula distributions. While the application is for flour milling, it has similarities with other processing industries which confront one or more ingredients, one or more outputs, and futures for one of the commodities and/or products. The paper develops utility maximizing models encompassing expected return and risk. Alternative scenarios are evaluated. First, the models were used to derive optimal hedge ratios, as well as various measures of risk and return under alternative scenarios, and hedge durations. The results indicated hedge ratios are typically less than 1. The hedge ratios for the Mean‐value‐at‐risk (M‐VaR)‐Copula model increased with greater durations. Second, the VaR for the M‐VaR‐Copula was in most cases less than the noncopula specifications. Thus, noncopula models may over state risk as represented by VaR.     

More reasons why farmers have so little interest in futures markets

The use by farmers of futures contracts and other hedging instruments has been observed to be low in many situations, and this has sometimes seemed to be considered surprising or even mysterious. We propose that it is, in fact, readily understandable and consistent with rational decision making. Standard models of the decision about optimal hedging show that it is negatively related to basis risk, to quantity risk, and to transaction costs. Farmers who have less uncertainty about prices and those with a diversified portfolio of investments have lower optimal levels of hedging. If a farmer has optimistic price expectations relative to the futures market, the incentive to hedge can be greatly reduced. And finally, farmers who have low levels of risk aversion have little to gain from hedging in terms of risk reduction, in that the certainty‐equivalent payoff at their optimal hedge may be little different than the certainty equivalent under zero hedging. These reasons are additional to the argument of Simmons (2002) who showed that, if capital markets are efficient, farmers can manage their risk exposure through adjusting their leverage, obviating the need for hedging instruments.     

Can satellite‐based weather index insurance improve the hedging of yield risk of perennial non‐irrigated olive trees in Spain?*

Olive oil yields fluctuate strongly due to their dependence on sufficient precipitation. An interesting option to hedge the yield risk in olive cultivation could be satellite‐based weather index insurance. Therefore, we implement index insurance as a hedging alternative for non‐irrigated olive groves using MODerate‐resolution Imaging Spectroradiometer (MODIS) satellite data. For this purpose, we focus on the Spanish region of Andalusia, given its importance in olive production at the international level. We calculate three satellite indices: the Vegetation Condition Index (VCI), the Temperature Condition Index (TCI) and the Vegetation Health Index (VHI). Meteorological indices related to temperature and precipitation are used as benchmarks. Firstly, we estimate the periods that have the greatest influence on the critical vegetative phase of olives, which extends from March to September. Based on the indices, insurance contracts are designed using a copula approach, which is then employed to evaluate their hedging effectiveness. On average, the hedging effectiveness of VCI‐, VHI‐ and TCI‐based weather index insurance contracts amounts to 38 per cent, 38 per cent and 29 per cent, respectively. Moreover, VCI‐ and VHI‐based weather index insurance contracts outperform traditional weather index insurance contracts based on precipitation (by 29 per cent) and temperature (by 16 per cent) indices.     

Potential demand for hedging by Australian wheat producers

The potential for hedging Australian wheat with the new Sydney Futures Exchange wheat contract is examined using a theoretical hedging model parametised from previous studies. The optimal hedging ratio for an ‘average’ wheat farmer was found to be zero under reasonable assumptions about transaction costs and based on previously published measures of risk aversion. The estimated optimal hedging ratios were found by simulation to be quite sensitive to assumptions about the degree of risk aversion. If farmers are significantly more risk averse than is currently believed, then there is likely to be an active interest in the new futures market.     

Opportunities and Pitfalls of International Futures Markets Trading by Developing Countries

Profitable direct and cross hedging opportunities exist for Zaire coffee hedgers, and some periods may offer significantly superior opportunities. External events and internal policy changes contributed to instability of Zaire hedge ratios. The importance of internal economic and financial changes must be considered to supplement international coffee market information. Other Third World Countries should consider the potential of using international commodities and financials futures markets for information and risk management in the trade of raw materials but be aware of changes in market and financial risks relative to their domestic situation.     

BASIS RISK AND HEDGING STRATEGIES FOR AUSTRALIAN WHEAT EXPORTS

Basis risk can play a significant role in the determination of effective hedging strategies. In this paper a portfolio framework is developed to examine the effect of basis risk on hedging strategies for Australian wheat exports. Monthly data for the period 1977 to 1984 were used to implement the analytical framework. While the traditional definition of hedging implies a hedge ratio of unity, the results of this research show that the average ratio of optimal hedge to stockholding is well below unity. Evolving market conditions can also cause the optimal hedge ratio to vary substantially over time.     

Insights from Anticipatory Prices

Contemporaneous observations on expected supply and on prices of post‐harvest futures contracts for corn are used to estimate expected demand relationships. These equations are used to estimate the prices of the post‐harvest contracts based on new supply estimates. Each estimate can be compared with a corresponding futures price, i.e. the market forecast. The differences help discern the market expectations about the expected demand for the new crop relative to historical experience, which can help support outlook analyses. We find that in recent years, a 100 million bushel change in the expected supply of corn results in about a 6 cent per bushel negative change in the price of December corn. The discussion also deepens understanding of the term ‘anticipatory prices’ as defined by Holbrook Working in his 1958 work.     

Managing economic risk in value-based marketing of fed cattle

This research investigates optimal price risk management strategies for fed cattle producers engaged in grid pricing. Stochastic simulation is used to determine optimal hedge ratios for fed cattle priced on a live weight basis or on a series of grids that vary in terms of premium/discount structure as well as base price. Results indicate that the optimal hedging strategy is greatly affected by the base price used in a particular grid. This has significant implications for pricing efficiency in the cattle market. Base prices that are linked more closely with downstream markets offer the potential to improve pricing efficiency; however, the risk associated with these prices is difficult to manage effectively with existing futures instruments.     

Developing Hedging Strategies for Québec Hog Producers under Revenue Insurance

The paper investigates the optimal hedging strategies of Québec hog producers when they participate in a publicly funded revenue insurance program known as ASRA (Régime d'assurance-stabilisation des revenus agricoles). A forecast model of local cash and futures prices is built and Monte Carlo methods are used to derive the optimal futures and option positions of Québec hog producers. The positive correlation between forecasts of futures and cash spot prices induces positive sales of futures and put options to hedge price risk. ASRA provides put options to hog producers at actuarially advantageous terms. Producers can increase the expected utility of profits by selling back a portion of these put options using financial markets. Options are attractive to manage price risk given the nonlinearity in the profit function induced by the revenue insurance scheme. Speculative incentives to use futures and options are also discussed in the context of ASRA.     

The use of organized commodity markets to manage food import price instability and risk

The article explores the possibility of insuring the price risks of wheat and maize imports of low‐income food‐deficit countries (LIFDCs). Optimal strategies for an importing agent, who hedges with futures and options are derived, based on the objective of minimizing the unpredictability of import bills. Ex post simulations for a set of LIFDCs are run on wheat and maize imports hedged with futures and options in the Chicago Board of Trade, to explore the extent to which hedging reduces the unpredictability in import bills. Simulations encompass both periods of normal price behavior, as well as the period of global upheaval that occurred in 2007 and 2008. Results show that hedging with futures alone affords agents considerable opportunities for reducing import cost unpredictability, and the same holds with options, albeit, to a lesser extent. However, during the recent price spike of 2007–2008, hedging with options would have increased the unpredictability of some countries’ maize import bills, due to the combination of erratic import patterns and pronounced market uncertainty.     

Finding optimal price risk management instruments: the case of the Spanish potato sector

This article offers a comprehensive analysis of the problem of choosing between alternative market risk management instruments. We model farmers' behavior to optimize the certainty equivalent, formulated by a mean–variance model, by combining instruments with and without basis risk. Results are expressed as the demands for hedging with futures, forward contracts and insurance. Theoretical results are applied to a selection of Spanish producers of fresh potatoes, a sector that is exposed to significant market risks. Amsterdam's Euronext provides potato futures prices, and the recently launched revenue insurance in Spain provides the example for price insurance. Three conclusions summarize the article's main findings. First, we show that Spanish potato revenue insurance subsidies are a factor that determines the instrument rankings and choice. Second, the efficiency of insurance subsidies is generally low. Finally, the Amsterdam potato futures market does not provide a cost‐effective means to manage price risks for Spanish fresh potato growers.     

Renewable versus nonrenewable resources: an analysis of volatility in futures prices

This study outlines a new approach for differentiating commodity futures based on their exhaustibility. Various aspects of volatility in the futures prices of renewable resources (palm oil, coffee, soya beans, rice, wheat and corn) and nonrenewable resources (zinc, aluminium, natural gas, gold, crude oil and copper) are studied, exploring whether volatility is greater in the former than in the latter. We use a generalised autoregressive conditional heteroskedasticity (GARCH) model to test our main hypothesis that the volatility in futures prices for renewable resources has recently been equal to or greater than the volatility in futures prices for nonrenewable resources. Our key findings suggest that futures prices for some renewable resources have greater variance than those for benchmark crude oil in a simulated GARCH series. We extend our analysis using a nonlinear vector smooth transition autoregressive (VSTAR) model to test for the existence of a shifting‐mean tendency in the commodity series that we researched. We show that transition from a stable to a volatile regime is more abrupt for renewable resources.     

Futures markets and real estate public equity: Connectivity of lumber futures and Timber REITs

This paper investigates connectivity between lumber futures contracts, Timberland REITs, the FTSE NAREIT U.S. REIT index, spot prices, and timberland capitalization rates, and contributes to this tranche of research by empirically linking the price discovery process of Timberland Real Estate Investment Trusts to lumber futures. We employ VEC and GARCH models, providing evidence that lumber futures have a positive significant long- and short-run equilibrium relationship with publicly traded Timber REIT prices, connecting a specific futures commodity with its theoretically entwined real estate equity index. As such, exogenous factors that influence Timber REIT prices are documented leading to possible diversification/risk reduction strategies.     

Why do farmers have so little interest in futures markets?

A farm financial model with leverage and investment in two farm enterprises is specified. The model is extended to incorporate futures hedging and the Separation Theorem is used to show that optimal hedging is zero. The assumption of a risk‐free asset is relaxed and, while this leads to a violation of the Separation Theorem, the result that optimal hedging is zero is maintained providing that futures markets are efficient. It is concluded that if capital markets are efficient then farmers will have little interest in futures markets except to speculate.     

Price Risk Management for Peanut Meal

Abstract

Peanut meal is cross-hedged with soybean meal using peanut meal cash prices and soybean meal futures prices. Hedge ratios are obtained for a 3-year and a 6-year period model. The data is from 1993 to 2000, with the 2000 data used for evaluation. All hedge ratios are significant and the 3-year period model's results suggest that long term data sets have less explanatory power than short-term hedge ratios. Evaluation results indicate positive gains for cross-hedged poultry producers and/or peanut producers. The empirical analyses suggest that soybean meal futures can be used as a potential cross-hedging vehicle for peanut meal.     

Alternative Hedging Strategies for an Alberta Feedlot Operator

This paper examines the feasibility of a Canadian producer using the U.S. futures markets to hedge specific products. “Multihedging” refers lo a situation where a producer uses several hedges to hedge both inputs and outputs and in doing so locks in a profit margin on his operation or minimizes his losses. In particular, the paper examines the feasibility of hedging two inputs (barley and feeder cattle) and one output (fat cattle). The Chicago Board of Trade corn contract is used to hedge barley; the Chicago Mercantile Exchange feeder cattle contract to hedge feeder cattle; and the Chicago Mercantile Exchange live cattle contract to hedge fat cattle. These hedges are evaluated in terms of the level of returns to the producer, the primary conclusion being that during the period from September, 1975, to January, 1978. an Alberta feedlot operator could have increased his income level by hedging, but in doing so. he would have incurred a greater degree of instability. Cette communication examine la faisabilité pour un producteur canadien d'utiliser le marchéà terme amèricain pour arbitrer desproduits spècifiques. Dans un “multiarbitrage,” un producteur se livre à plusieurs arbitrages sur les entrèes et les sorties; cefaisant, il obtient une marge bénéficiaire ou minimise ses pertes. Cette communication examine en particulier la faisabilité d'arbitrer deux entrèes (orge et betail destinè a la boucherie) et une sortie (bétail engraissè). On utilise le contrat de maïs du “Chicago Board of Trade” pour arbitrer I'orge, le contrat des animaux de boucherie du “Chicago Mercantile Exchange” pour arbitrer les animaux de boucherie, le contrat de bétes sur pied du “Chicago Mercantile Exchange” pour arbitrer le bétail engraissé. On évalue ces arbitrages en fonclion des revenus qu'ils rapportent auproducteur tels que mesuréspar la moyenne et enfonction des variations dans les revenus tels que mesurées par l‘écart.     

The Current State of the Russian Agricultural Sector

Russia's agriculture produces around 3.7 per cent of the country's GDP, employs 9.2 per cent of the national workforce and contributes around 6 per cent of the country's exports. The sector has shown remarkable resilience in the face of wider economic turbulence. Self‐sufficiency rates for the main agricultural commodities are relatively high. Agricultural exports have grown very significantly since 2000 especially for wheat and meslin (wheat and rye mixture). Meat production has been growing steadily, particularly in the poultry and pork sectors. Whilst the agri‐food sector has great potential to play an even more prominent role in Russia's economy, it suffers from relatively low productivity and an outdated technological base. The main drive for efficiency has come mainly from the relatively large‐scale agricultural firms, who generated more than half of the total value of agricultural output in 2016. Foreign policy instability, including economic sanctions, the devaluation of the national currency and declining economic growth have weakened the sector and caused an increase in the prices of imported goods and equipment. At the same time Russian products have replaced high value‐added imports and Russia's agricultural producers are expanding into new markets.