Journal of Financial and Quantitative Analysis Vol. 58 No. 3 2023
Hedging Commodity Price Risk
Abstract
We present an equilibrium model of hedging for commodity processing firms. We show the optimal hedge ratio depends on the convexity of the firm’s cost function and the elasticity of the supply of the input and the demand for the output. Our calibrated model suggests that hedging tends to be ineffective. When uncertainty comes exclusively from either the supply or from the demand side, updating the hedge dynamically, and using nonlinear contracts improves hedging effectiveness. However, with both supply and demand uncertainty, hedging effectiveness can be low even with option-based and dynamic hedging strategies.
- DOI
- 10.1017/s0022109022001478
- Volume
- 58
- Issue
- 3
- Pages
- 1202-1229
- Language
- en
- Sources
- bibtex:phds-export.bib openalex crossref