Evaluating the Hedging Performance of Oil and Oilseeds Futures in India

Meenakshi Malhotra

Paradigm, 2015, vol. 19, issue 2, 184-196

Abstract: The risk of commodity price volatility impacts almost everyone from individuals to companies and the economy as a whole. Hedging with derivative instruments is a way to insure against such risks. In the present study, the risk reduction function of commodity futures has been evaluated for commodities in the oil and oilseeds segment, namely, refined soya oil, mustard seed, mentha oil and crude palm oil (CPO). The choice of these commodities is made because in India, oilseeds’ trading has grown phenomenally due to massive increase in its domestic consumption which is being met by imports. To attain self-sufficiency and to enhance domestic production, besides other measures, commodity futures help to improve price realization and thereby encourage farmers to increase the area under cultivation. The minimum variance hedge ratio (MVHR) is calculated using the ordinary least square (OLS) method, OLS with additional variables and error correction model (ECM). Hedging effectiveness is quantified using MVHR. The estimates of hedging effectiveness are satisfactory for more liquid futures contracts of refined soya oil and CPO which gave variance reduction to the extent of 55 and 71 per cent, respectively. On the other hand, risk reduction with mustard seed and refined mentha oil futures is only around 28 per cent. According to market reports, the latter are narrow commodities with a small market size and greater susceptibility to price manipulation and cartelization. Measures, such as, better regulatory framework, wider participation of actual users in the commodity value chain and suitable contract specifications, are most essential for lucrative commodity markets.

Keywords: Edible oil; oilseeds; commodity futures; hedge ratio; hedging effectiveness; error correction model (search for similar items in EconPapers)
Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:sae:padigm:v:19:y:2015:i:2:p:184-196

DOI: 10.1177/0971890715609990

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