Hedging Risk For Feeder Cattle With A Traditional Hedge Compared To A Ratio Hedge

Abstract

This paper compares hedging risk for various weights of feeder cattle hedged with a traditional cross hedge and a ratio cross hedge. A traditional hedge calls for the purchase/sale of one pound of futures for each pound of cash feeder cattle. By contrast, a ratio hedge requires estimation of a hedge ratio to determine the number of pounds of futures needed to hedge one pound of cash feeder cattle. Hedge ratios were found to be larger than 1.0 for light-weight feeder cattle. By using the estimated hedge ratios, it was shown that hedging risk could be reduced 20-50 percent compared to that achieved by using a hedge ratio of 1.0.

Hedging effectiveness of fertilizer swaps

“…Following the work of Ederington (1979) and Elam and Davis (1990), week to week hedge ratios are calculated using OLS regressions. The resulting model is:…”

Hedge ratios and basis behavior: An intuitive insight?

“…An example of net price forecasting with a hedge ratio using Lubbock, Texas, cash cotton price and N.Y. March cotton futures price levels provides an indication of basis risk associated with minimum risk forecast net prices, Table 1.6 This is a cross-hedge 'Elam and Davis (1990) have presented a detailed illustration of ratio hedged basis risk versus a 100% hedge basis risk using feeder cattle. They also derived a generalized basis formula but did not pursue the basis behavior aspect (p. 212).…”

“…If, in fact, the market is efficient and price forecasts are not sufficiently reliable, then one is left in the second best situation of forecasting the ex post hedge net price using an estimated hedge ratio. If a fairly strong relationship between closing cash and futures prices is present, the net price forecasting process should provide a better estimate of end-of-hedge net price, subject to basis risk, than simply using a 100% hedge unless, of course, the ratio is one [Elam and Davis (1990) If dependable price change forecasts are available, the portfolio approach maximizing profit subject to some level of risk may be appropriate. A forecast price increase would suggest reduced short hedging, possible to the point of "a Texas hedge" and vice versa [Miller (1986)l.…”

“…The argument is that the hedge ratio simply indicates the basis behavior at the end of the hedge or, in the case of price changes, during the life of the hedge. Hedge ratios from regressed price levels reveal closing basis behavior and are useful for forecasting the net price resulting from the hedge [Elam and Davis (1990)l. Hedge ratios from regressed price changes give some insight into basis behavior during the hedge and also permit forecasting the net price expected to result from the hedge.…”

Sell now or later? A decision-making model for feeder cattle selling

“…Similarly motivated hedonic models have been used in feeder cattle markets to examine local basis behavior (Mallory et al 2016) and optimal hedge ratios (Elam and Davis 1990;Bina, Schroeder, and Tonsor 2021). Matching methods (e.g., nearest neighbor, propensity score matching) have received less attention but with a similar goal of estimating premiums of alternative "value-added" management practices (Williams et al 2014a(Williams et al , 2014b.…”