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Futures Hedging Under Price, Basis, and Production Risk
Author(s) -
Lapan Harvey,
Moschini Giancarlo
Publication year - 1994
Publication title -
american journal of agricultural economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.949
H-Index - 111
eISSN - 1467-8276
pISSN - 0002-9092
DOI - 10.2307/1243658
Subject(s) - futures contract , hedge , econometrics , normality , basis risk , economics , basis (linear algebra) , variance (accounting) , production (economics) , log normal distribution , yield (engineering) , mathematics , financial economics , microeconomics , statistics , ecology , materials science , geometry , accounting , capital asset pricing model , metallurgy , biology
We consider the hedging problem of a firm that has three sources of risk: price, basis, and yield uncertainty. An exact solution for the optimal futures hedge is derived under the assumption that the three random variables are jointly normally distributed and that utility is of the CARA type. Unlike the mean‐variance approximation applied in previous research, we show that the optimal hedge does depend on risk attitudes, even when the agent perceives the futures price as being unbiased. The theoretical results are applied empirically to the problem of hedging soybean production in Iowa. The exact solution, relying on CARA and normality, is compared with numerical solutions under lognormal distributions and CRRA utility.