Risk management and market conditions |
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Affiliation: | 1. King''s Business School, King''s College London, Level 1, Bush House, 30 Aldwych, London WC2B 4BG, United Kingdom;2. Department of Finance, CUHK Business School, The Chinese University of Hong Kong, Shatin, NT, Hong Kong, China;1. Department of Finance, Faculty of Business and Law, Deakin University, 221 Burwood Highway, Burwood, VIC 3125, Australia;2. School of Economics, Finance and Marketing, RMIT University, Australia;3. School of Banking, University of Economics Ho Chi Minh City, 59C Nguyen Dinh Chieu Street, District 3, Ho Chi Minh City, Viet Nam |
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Abstract: | In this paper, we investigate the relation between hedging activity by commercial/merchant/producers to commodity prices and commodity market volatility using Commitments of Traders reports from commodity futures markets exchanges. Qualifying the body of literature which attributes hedging activity to departures from Modigliani-Miller theory, market imperfections and transactions cost, we address the paradoxes of hedging which is not value creating and the absence of hedging when firms might benefit, arguing that it may be related to the market conditions and risk appetite. We discover that prices and volatility are generally statistically significant contributors to hedging activity by commercial/merchant/producers’ users but with marked differences in their elasticities. For some commodities, price levels alone and not volatility are significant. We demonstrate that analysis of hedging in commodity markets should take cognisance of conditions and the degree of risk aversion, otherwise the implicit assumption is that hedging is invariant to such matters. Through considering both market conditions and the degree of risk aversion, understanding the motivation for hedging may be enhanced. |
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