Basis Expectations and Soybean Hedging Effectiveness

Abstract

There are two issues which form the central focus of the paper: a) the role of basis expectations in measuring hedging effectiveness (HE), and b) the behavior of HE over time and space. An HE conceptual model is developed which emphasizes the explicit specification of the hedger's basis expectation. Alternative soybean basis expectation (forecast) models are then evaluated. One of two models—both of which are simple and practical—perform best, depending on contract expiration. An analysis of HE during 1966 to 1983 indicates that there was an increase in the risk‐shifting opportunity associated with the soybean futures market, and that the possibility of nonstationary (over time) and nonconstant (over space) hedging effectiveness needs to be considered when analyzing direct and cross hedges.