Looking into the futures markets: What are they really for?

Sören Prehn, Thomas Glauben and Jens-Peter Loy

No 310053, IAMO Policy Briefs from Institute of Agricultural Development in Transition Economies (IAMO)

Abstract: First things first - contrary to popular opinion, the main reason farmers and grain traders use futures markets is not to hedge spot price and basis risks, but to ensure the profitability of the storage business. The scientific literature mainly discusses the minimum variance hedge ratio, which aims at minimizing spot price and basis risks. In practice, however, it is of little use to farmers and grain traders and has the potential to yield negative economic consequences. Minimum variance hedging (MVH) leads to over-hedging on inverse markets and under-hedging on carry markets. In both cases, the costs of storage cannot be (adequately) covered. It is therefore not surprising that farmers and grain traders do not actually use MVH. On a carry market, a good strategy is to trade the basis. The opposite is true for inverse markets where hedging on futures markets does not make sense. Here, it is better to follow a rather speculative strategy that takes account of price trends. In a nutshell: buy on a weak basis and sell on a strong basis (carry market), or speculate (inverse market).

Keywords: Agricultural Finance; International Relations/Trade; Risk and Uncertainty (search for similar items in EconPapers)
Pages: 6
Date: 2021
New Economics Papers: this item is included in nep-ore and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:ags:iamopb:310053

DOI: 10.22004/ag.econ.310053

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