Hedging with futures during nonconvergence in commodity markets

Alankrita Goswami, Berna Karali and Michael Adjemian

Journal of Commodity Markets, 2023, vol. 32, issue C

Abstract: Hedging in grain futures markets offers market participants the opportunity to mitigate the price risk in spot markets by taking offsetting positions in futures. The performance of a traditional minimum variance hedge ratio (MVHR) relies on the correlation between the spot and futures price changes. During 2005–2010, delivery-location cash prices for several crops decoupled from the prices for their related expiring futures contracts—raising concerns over the hedging effectiveness of these contracts. We investigate how short hedgers, like farmers, performed during periods with and without convergence in corn, soybean, and wheat markets. We show that, ex post, MVHR, often does not minimize the variance of wheat producers’ profits during nonconvergence when compared to a range of other hedging choices. We also find that the performance of MVHR weakens during years with low carryover. We further assess hedging performance of MVHR and other hedge ratios in achieving higher net selling prices, and find that nonconvergence particularly impairs their performance in the wheat market where the nonconvergence anomaly was the most prominent. Taken together, our results raise questions on the role of futures markets as risk management tools during nonconvergence episodes regardless of how the hedge ratio is chosen.

Keywords: Cash price; Corn; Futures price; Minimum variance hedge ratio; Nonconvergence; Soybean; Wheat (search for similar items in EconPapers)
JEL-codes: G13 Q11 Q13 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jocoma:v:32:y:2023:i:c:s2405851323000545

DOI: 10.1016/j.jcomm.2023.100364

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