A Note on Futures Markets with Small Price and Production Risks

Yuzo Honda and Hiroshi Ohta

International Economic Review, 1992, vol. 33, issue 2, 479-86

Abstract: When the spot price and production risk are jointly normally distributed, the mean-variance approach has little theoretical justification. The authors use Taylor approximations instead and show the three results. One, farmers hedge less than expected production when the futures price is less than or equal to the expected spot price. Two, when the futures price equals the expected spot price, farmers facing production risk produce less than those without production risk. Three, normal backwardation (contango) prevails in the markets when correlation between the spot price and production risk is smaller (greater) in absolute value than the ratio of coefficients of variation of these variables. Copyright 1992 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Date: 1992
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