Hostname: page-component-7b7567c8c-kwt9d Total loading time: 0 Render date: 2026-11-14T23:22:17.223Z Has data issue: false hasContentIssue false
  • English
  • Français

Hedging Commodity Price Risk

Published online by Cambridge University Press:  12 December 2022

Hamed Ghoddusi,
Sheridan TitmanOpen the ORCID record for Sheridan Titman[Opens in a new window] and
Stathis Tompaidis
Hamed Ghoddusi
Affiliation:
California Polytechnic State University Orfalea College of Business hghoddus@calpoly.edu
Sheridan Titman*
Affiliation:
University of Texas at Austin McCombs School of Business
Stathis Tompaidis
Affiliation:
University of Texas at Austin McCombs School of Business Stathis.Tompaidis@mccombs.utexas.edu
*
Sheridan.Titman@mccombs.utexas.edu (corresponding author)
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the 'Save PDF' action button.

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.

Information

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 58 , Issue 3 , May 2023, pp. 1202 - 1229
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We also thank participants and discussants for their input at seminars at HEC Montreal, Oxford Institute for Energy Studies, UTAustin, UC Berkeley, Humboldt University, Rutgers, Alberta Finance Institute Conference, BI Norwegian Business School, Athens University of Economics and Business, Sharif University of Technology, UC Davis, HEC Paris, University of Vienna, UQAM Montreal, the Commodity Futures Trading Commission (CFTC), the 2011 Applied Financial Economics conference, the 2011 International Conference on Mathematical and Financial Economics, the 2011 CFTC Conference on Commodities Markets, the 2012 Workshop on Probability and Statistics in Finance, the 2012 Alberta Finance Institute Conference on Speculation, Risk Premiums, and Financing Conditions in Commodity Markets, “the 2015 workshop on Commodities and Financialization at the Institute for Pure and Applied Mathematics, the 2019 Oklahoma University Energy and Commodities Finance Research Conference, and the 2019 Supply Chain Finance and Risk Management Workshop.”

References

Bartram, S. M. “Corporate Hedging and Speculation with Derivatives.” Journal of Corporate Finance, 57 (2017), 9–34.CrossRefGoogle Scholar
Bartram, S. M.; Brown, G. W.; and Minton, B. A.. “Resolving the Exposure Puzzle: The Many Facets of Exchange Rate Exposure.” Journal of Financial Economics, 95 (2010), 148–173.CrossRefGoogle Scholar
Bessembinder, H., and Lemmon, M. L.. “Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets.” Journal of Finance, 57 (2002), 1347–1382.CrossRefGoogle Scholar
Breeden, D. T., and Viswanathan, S.. “Why Do Firms Hedge? An Asymmetric Information Model.” Journal of Fixed Income, 25 (2015), 7–25.CrossRefGoogle Scholar
Brown, G. W., and Toft, K. B.. “How Firms Should Hedge.” Review of Financial Studies, 15 (2002), 1283–1324.CrossRefGoogle Scholar
Carter, D. A.; Rogers, D. A.; Simkins, B. J.; and Treanor, S. D.. “A Review of the Literature on Commodity Risk Management.” Journal of Commodity Markets, 8 (2017), 1–17.CrossRefGoogle Scholar
Casassus, J.; Liu, P.; and Tang, K.. “Economic Linkages, Relative Scarcity, and Commodity Futures Returns.” Review of Financial Studies, 26 (2012), 1324–1362.CrossRefGoogle Scholar
Cooper, J. C. “Price Elasticity of Demand for Crude Oil: Estimates for 23 Countries.” OPEC Energy Review, 27 (2003), 1–8.CrossRefGoogle Scholar
Dale, S. “New Economics of Oil.” Oil and Gas, Natural Resources, and Energy Journal, 1 (2016), 365.Google Scholar
DeMarzo, P. M., and Duffie, D.. “Corporate Incentives for Hedging and Hedge Accounting.” Review of Financial Studies, 8 (1995), 743–771.CrossRefGoogle Scholar
Dybvig, P. H.; Liang, P. J.; and Marshall, W. J.. “The New Risk Management: The Good, the Bad, and the Ugly.” Federal Reserve Bank of St. Louis Review, 95 (2013), 273–292.Google Scholar
Fehle, F., and Tsyplakov, S.. “Dynamic Risk Management: Theory and Evidence.” Journal of Financial Economics, 78 (2005), 3–47.CrossRefGoogle Scholar
Froot, K. A.; Scharfstein, D. S.; and Stein, J. C.. “Risk Management: Coordinating Corporate Investment and Financing Policies.” Journal of Finance, 48 (1993), 1629–1658.CrossRefGoogle Scholar
Gilje, E. P., and Taillard, J. P.. “Does Hedging Affect Firm Value? Evidence from a Natural Experiment.” Review of Financial Studies, 30 (2017), 4083–4132.CrossRefGoogle Scholar
Graham, J. R., and Smith, C. W.. “Tax Incentives to Hedge.” Journal of Finance, 54 (1999), 2241–2262.CrossRefGoogle Scholar
Guay, W., and Kothari, S. P.. “How Much Do Firms Hedge with Derivatives?” Journal of Financial Economics, 70 (2003), 423–461.CrossRefGoogle Scholar
Hirshleifer, D. “Residual Risk, Trading Costs, and Commodity Futures Risk Premia.” Review of Financial Studies, 1 (1988a), 173–193.CrossRefGoogle Scholar
Hirshleifer, D. “Risk, Futures Pricing, and the Organization of Production in Commodity Markets.” Journal of Political Economy, 96 (1988b), 1206–1220.CrossRefGoogle Scholar
Hirshleifer, D. “Seasonal Patterns of Futures Hedging and the Resolution of Output Uncertainty.” Journal of Economic Theory, 3 (1991), 304–327.CrossRefGoogle Scholar
Ho, T. S. “Intertemporal Commodity Futures Hedging and the Production Decision.” Journal of Finance, 39 (1984), 351–376.CrossRefGoogle Scholar
Hoberg, G., and Moon, S. K.. “Offshore Activities and Financial vs Operational Hedging.” Journal of Financial Economics, 125 (2017), 217–244.CrossRefGoogle Scholar
Hughes, J.; Knittel, C.; and Sperling, D.. “Evidence of a Shift in the Short-Run Price Elasticity of Gasoline Demand.” Energy Journal, 29 (2008), 113–134.CrossRefGoogle Scholar
Jin, Y., and Jorion, P.. “Firm Value and Hedging: Evidence from US Oil and Gas Producers.” Journal of Finance, 61 (2006), 893–919.CrossRefGoogle Scholar
Kamara, A. “Production Flexibility, Stochastic Separation, Hedging, and Futures Prices.” Review of Financial Studies, 6 (1993), 935–957.CrossRefGoogle Scholar
Lievenbrück, M., and Schmid, T.. “Why Do Firms (not) Hedge? Novel Evidence on Cultural Influence.” Journal of Corporate Finance, 25 (2014), 92–106.CrossRefGoogle Scholar
Liu, W. “Modeling Gasoline Demand in the United States: A Flexible Semiparametric Approach.” Energy Economics, 45 (2014), 244–253.CrossRefGoogle Scholar
Mello, A. S., and Parsons, J. E.. “Hedging and Liquidity.” Review of Financial Studies, 13 (2000), 127–153.CrossRefGoogle Scholar
Routledge, B. R.; Spatt, C. S.; and Seppi, D. J.. “The ‘Spark Spread’: An Equilibrium Model of Cross-Commodity Price Relationships in Electricity.” gSIA Working Papers 1999-15, Carnegie Mellon University (1998).Google Scholar
Shapiro, A. C., and Titman, S.. “An Integrated Approach to Corporate Risk Management.” In Stern, J. and Chew, D., eds. The Revolution in Corporate Finance. New York, NY: Basil Blackwell (1986), 331–354.Google Scholar
Smith, C. W., and Stulz, R. M.. “The Determinants of Firms’ Hedging Policies.” Journal of Financial and Quantitative Analysis, 20 (1985), 391–405.CrossRefGoogle Scholar
Strebulaev, I. A., and Whited, T. M.. “Dynamic Models and Structural Estimation in Corporate Finance.” Foundations and Trends in Finance, 6 (2012), 1–163.CrossRefGoogle Scholar