Substitution between revenue futures and price futures contracts: A note

Hennessy, David A.

doi:10.1002/fut.10014

Cited by 5 publications

(6 citation statements)

References 5 publications

(8 reference statements)

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“…Instruments with nonlinear payoffs such as options can reduce downside risk while 3 More recently, related research in the agricultural risk-management literature has looked at innovations in agricultural output insurance markets such as revenue insurance products. For example, Hennessy (2002) analyzed the substitutability between price futures contracts and revenue futures contracts and explored issues pertaining to hedging performance, market completeness, and the resulting policy implications.…”

Section: Prior Research On the Linear/ Nonlinear Instrument Choicementioning

confidence: 99%

On the optimal mix of corporate hedging instruments: Linear versus nonlinear derivatives

Nam

Turac

2003

Journal of Futures Markets

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We examine how corporations should choose their optimal mix of linear and nonlinear derivatives. We present a model in which a firm facing both quantity (output) and price (market) risk maximizes its expected profits when subjected to financial distress costs. The optimal hedging position generally is comprised of linear contracts, but as the levels of quantity and price-risk increase, the use of linear contracts will decline due to the risks associated with overhedging. At the same time, a substitution effect occursThe authors acknowledge the helpful comments and conversations we have had with Mike Rebello, Steve Smith, Alan Tucker, P. V. Viswanath, Jayant Kale, Tom Webster, and seminar participants at Pace University and the University of South Florida. They also are appreciative of the comments provided by an anonymous reviewer. Smithson (1998) for an excellent summary and also the seminal articles of DeMarzo and Duffie (1995), Froot, Scharfstein, and Stein (1993), and Smith and Stulz (1985. 2 A professional version of this article, with anecdotal and empirical support for our hypotheses, appears in Gay, Nam, and Turac (2002). toward the use of nonlinear contracts. The degree of substitution will depend on the correlation between output levels and prices. Our model also allows us to provide insight into the relation between a firm's derivatives usage and its transaction-cost structure.

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Section: Prior Research On the Linear/ Nonlinear Instrument Choicementioning

confidence: 99%

On the optimal mix of corporate hedging instruments: Linear versus nonlinear derivatives

Nam

Turac

2003

Journal of Futures Markets

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“…From the three first-order conditions, and the separation result can be derived such that the optimal output level is set at q* where . For details, see Hennessy (2002). Suppose that both futures prices are unbiased and the firm is a variance minimizer.…”

Section: The Perfect Substitute Modelmentioning

confidence: 99%

“…There will be trading in price futures contracts, but not for hedging purposes. Hennessy (2002) imposed the following assumption on price-yield co-dependence: with . Consequently, ϭ .…”

Section: The Perfect Substitute Modelmentioning

confidence: 99%

“…One might therefore wonder whether opportunities exist for developing exchange-traded derivative markets in revenue contracts for use by hedging producers, processors, and insurers. Hennessy (2002) identifies conditions under which price futures and revenue futures contracts are perfect substitutes. The identified substitution conditions are driven by a specific demand function that requires all yield risk to be systematic.…”

Section: Introductionmentioning

confidence: 99%

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A note on price futures versus revenue futures contracts

Lien

Hennessy

2004

Journal of Futures Markets

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Here we consider the hedging roles of a price futures contract versus a revenue futures contract. In the absence of idiosyncratic output risk, the revenue contract almost always dominates the price contract. Idiosyncratic output risk provides conditions under which the price contract should dominate. When production risk is largely idiosyncratic, a producer with an anticipated long actuals position might combine a long revenue futures position with a short price futures position.

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“…1 1 In agricultural markets, crop insurance, derivatives on crop yields, and some revenue contracts are available to manage quantity (or yield) risks for farmers. See, for example, Li and Vukina (1998), Coble, Heifner, and Zuniga (2000), Tomek and Peterson (2001), Hennessy (2002), and Mahul and Wright (2003). …”

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confidence: 99%

Handling Weather Related Risks Through the Financial Markets: Considerations of Credit Risk, Basis Risk, and Hedging

Golden

Wang

Yang

2007

J of Risk & Insurance

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The profits of many businesses are strongly affected by weather related events, and insurance against weather related risks (acts of God) has been a traditional domain for transfer of (certain) of these risks. Recent innovations in the capital market have now provided financial instruments to transfer and hedge some of these risks. Unlike insurance solutions, however, using these financial derivative instruments creates a situation in which the return to the purchaser of the instrument is no longer perfectly correlated with the loss experienced. Such a mismatch creates new risks which must be examined and evaluated as part of ascertaining cost effective risk management plans. Two newly engendered risks, basis risk (the risk created by the fact that the return from the financial derivative is a function of weather at a prespecified geographical location which may not be identical to the location of the firm) and credit risk (the risk that the counterparty to the derivative contract may not perform), are analyzed in this article. Using custom tailored derivatives from the over the counter market can decrease basis risk, but increases credit risk. Using standardized exchange traded derivatives decreases credit risk but increases basis risk. Here also the effectiveness of using hedging methods involving forwards and futures having linear payoffs (linear hedging) and methods using derivatives having nonlinear payoffs such as those involving options (nonlinear hedging) for the purpose of hedging basis risk are examined jointly with credit risk. Copyright The Journal of Risk and Insurance, 2007.

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Substitution between revenue futures and price futures contracts: A note

Cited by 5 publications

References 5 publications

On the optimal mix of corporate hedging instruments: Linear versus nonlinear derivatives

On the optimal mix of corporate hedging instruments: Linear versus nonlinear derivatives

A note on price futures versus revenue futures contracts

Handling Weather Related Risks Through the Financial Markets: Considerations of Credit Risk, Basis Risk, and Hedging

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