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Determining the effectiveness of optimal time‐varying hedge ratios for cattle feeders under multiproduct and single commodity settings

Determining the effectiveness of optimal time‐varying hedge ratios for cattle feeders under... Purpose – The purpose of this paper is to determine and contrast the risk mitigating effectiveness from optimal multiproduct time‐varying hedge ratios, applied to the margin of a cattle feedlot operation, over single commodity time‐varying and naive hedge ratios. Design/methodology/approach – A parsimonious regime‐switching dynamic correlations (RSDC) model is estimated in two‐stages, where the dynamic correlations among prices of numerous commodities vary proportionally between two different regimes/levels. This property simplifies estimation methods for a large number of parameters involved. Findings – There is significant evidence that resulting simultaneous correlations among the prices (spot and futures) for each commodity attain different levels along the time‐series. Second, for in and out‐of‐sample data there is a substantial reduction in the operation's margin variance provided from both multiproduct and single time‐varying optimal hedge ratios over naive hedge ratios. Lastly, risk mitigation is attained at a lower cost given that average optimal multiproduct and single time‐varying hedge ratios obtained for corn, feeder cattle and live cattle are significantly below the naive full hedge ratio. Research limitations/implications – The application studied is limited in that once a hedge position has been set at a particular period, it is not possible to modify or update at a subsequent period. Practical implications – Agricultural producers, specifically cattle feeders, may profit from a tool using improved techniques to determine hedge ratios by considering a larger amount of up‐to‐date information. Moreover, these agents may apply hedge ratios significantly lower than one and thus mitigate risk at lower costs. Originality/value – Feedlot operators will benefit from the potential implementation of this parsimonious RSDC model for their hedging operations, as it provides average optimal hedge ratios significantly lower than one and sizeable advantages in margin risk mitigation. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Agricultural Finance Review Emerald Publishing

Determining the effectiveness of optimal time‐varying hedge ratios for cattle feeders under multiproduct and single commodity settings

Hernan Tejeda; Dillon Feuz
Agricultural Finance Review , Volume 74 (2): 19 – Jul 1, 2014
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References (44)

Publisher
Emerald Publishing
Copyright
Copyright © 2014 Emerald Group Publishing Limited. All rights reserved.
ISSN
0002-1466
DOI
10.1108/AFR-11-2013-0038
Publisher site
See Article on Publisher Site

Abstract

Purpose – The purpose of this paper is to determine and contrast the risk mitigating effectiveness from optimal multiproduct time‐varying hedge ratios, applied to the margin of a cattle feedlot operation, over single commodity time‐varying and naive hedge ratios. Design/methodology/approach – A parsimonious regime‐switching dynamic correlations (RSDC) model is estimated in two‐stages, where the dynamic correlations among prices of numerous commodities vary proportionally between two different regimes/levels. This property simplifies estimation methods for a large number of parameters involved. Findings – There is significant evidence that resulting simultaneous correlations among the prices (spot and futures) for each commodity attain different levels along the time‐series. Second, for in and out‐of‐sample data there is a substantial reduction in the operation's margin variance provided from both multiproduct and single time‐varying optimal hedge ratios over naive hedge ratios. Lastly, risk mitigation is attained at a lower cost given that average optimal multiproduct and single time‐varying hedge ratios obtained for corn, feeder cattle and live cattle are significantly below the naive full hedge ratio. Research limitations/implications – The application studied is limited in that once a hedge position has been set at a particular period, it is not possible to modify or update at a subsequent period. Practical implications – Agricultural producers, specifically cattle feeders, may profit from a tool using improved techniques to determine hedge ratios by considering a larger amount of up‐to‐date information. Moreover, these agents may apply hedge ratios significantly lower than one and thus mitigate risk at lower costs. Originality/value – Feedlot operators will benefit from the potential implementation of this parsimonious RSDC model for their hedging operations, as it provides average optimal hedge ratios significantly lower than one and sizeable advantages in margin risk mitigation.

Journal

Agricultural Finance Review – Emerald Publishing

Published: Jul 1, 2014

Keywords: Feedlot operators; Multiproduct optimal hedging; Regime‐switching models; Time‐varying hedge ratios

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