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The Demand for Hedging with Futures and Options
Author(s) -
Frechette Darren L.
Publication year - 2001
Publication title -
journal of futures markets
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.88
H-Index - 55
eISSN - 1096-9934
pISSN - 0270-7314
DOI - 10.1002/fut.1801
Subject(s) - futures contract , hedge , economics , portfolio , marginal cost , marginal utility , microeconomics , financial economics , ecology , biology
The optimal hedging portfolio is shown to include both futures and options under a variety of circumstances when the marginal cost of hedging is nonzero. Futures and options are treated as substitute goods, and the properties of the resulting hedging demand system are explained. The overall optimal hedge ratio is shown to increase when the marginal cost of trading options is reduced. The overall optimal hedge ratio is shown to decrease when the marginal cost of trading futures is decreased. One implication is that hedging demand can be stimulated by a reduction in the perceived cost of trading options through the education of hedgers about options and the initiation of programs such as the Dairy Options Pilot Program. The demand approach is applied to estimate optimal hedge ratios for dairy producers hedging corn inputs in five regions of Pennsylvania. © 2001 John Wiley & Sons, Inc. Jrl Fut Mark 21:693–712, 2001