Futures markets in an open economy

Jae-Gyeong Kim

ISU General Staff Papers from Iowa State University, Department of Economics

Abstract: The purpose of this dissertation is to analyze the competitive firm's behavior under the price and exchange rate uncertainty when the firm participates in futures markets to hedge against these risks. This dissertation deals with three theoretical models which consider three different firms, and one empirical study. The first model shows that if the producing firm which trades in international and domestic markets uses the futures markets, the separation theorem holds, and the production decision does not depend on the risk attitudes or probability distribution of the random variables, but marketing (and hedging) decisions are still affected by uncertainty even though there are hedging instruments. The second model shows that the separation theorem still holds even under the existence of basis risk. In third theoretical model an importing offshore firm which has access to U.S. futures market and face input price and exchange rate uncertainty is analyzed. Introducing both hedging markets to the offshore country encourages the offshore firm to increase its production by increasing imports. In empirical study, time series data relating to a Korean importing are investigated as to whether they are stationary or not by using Dickey-Fuller method and Kwiatkowski, Phillips, Schmidt and Shin method. The conditional moments method is used to solve the nonstationarity problem and to estimate the optimal commodity and currency hedge ratios and the effects of introducing hedging markets to a Korean firm. This dissertation provides some insights into the risk shifting role of futures market and marketing strategy between domestic and foreign markets when both hedging markets are available.

Date: 1993-01-01
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