1. Agricultural Marketing
ECON 337:
Agricultural Marketing
Lee Schulz
Assistant Professor 1

2. Cross Hedging
Not all markets have relevant actively traded futures contract
Either the futures market does not exist, or perhaps it is very illiquid
Examples: Sorghum

3. Cross Hedging
If the market you are interested in has no futures contract, but its price is highly correlated with a traded commodity you can hedge with the related contract
Sorghum:
Cereal grain used for feed, but has no futures contract
Price is highly correlated with the price of corn
Can hedge with the corn contract if you are a producer or consumer of sorghum

4. Cross Hedging
What is the biggest condition for a successful cross hedge?
Correlation between the commodity you want to hedge, and the traded commodity

5. Cross Hedging
If your cross hedge is successful you will have

6. Cross Hedging
Divide through by

7. Cross Hedging Divide through by
If S and F are perfectly correlated, then the hedge ratio
should equal 1

8. Cross Hedging
If S and F are not perfectly correlated, then you should not hedge 1:1 with the related contract
What hedge ratio should you use?

9. Cross Hedging
Want to estimate how price changes in our commodity are related to price changes in the traded commodity

10. Cross Hedging
Want to estimate how price changes in our commodity are related to price changes in the traded commodity
Proper hedge ratio is the estimate of in the regression above

11. Cross Hedging
This means that we should only hedge 65% of our sorghum

12. Class web site: