OFOR Recent and Forthcoming Publications


Mattos, F., P. Garcia and C.H. Nelson. (Forthcoming) “Relaxing Standard Hedging Assumptions in the Presence of Downside Risk.”  Quarterly Review of Economics and Finance.

Abstract

We analyze how the introduction of a downside risk measure and less restriction assumptions in the standard hedging problem changes the optimal hedge and the opportunity costs of not hedging.  Based on a dataset of futures and cash returns for soybeans and S&P 500 returns, the findings indicate that the optimal hedge changes considerably when a one-sided risk measure is adopted and standard assumptions are relaxed.  Further, the results suggest that in a downside risk framework with realistic hedging assumptions there is little or no incentive for producers to hedge as the opportunity cost of not hedging is small.

 

 Egelkraut, T.M. and P. Garcia. (Forthcoming) “Predicting S&P 500 Volatility for Intermediate Time Horizons using Implied Forward Volatility.”  Applied Economics Letters.

 Abstract

This paper finds that the implied forward volatility of S&P 500 futures options contains significant explanatory power regarding subsequent realized volatility during intermediate future time intervals.  It provides rational, unbiased, and informationally efficient predictions and dominates all alternative volatility forecasts considered.

 

Egelkraut, T.M., P. Garcia and B.J. Sherrick. (Forthcoming) “The Term Structure of the Implied Forward Volatility:  Recovery and Informational Content in Corn Options.”  American Journal of Agricultural Economics.

 Abstract

Using a flexible method, we develop the term structure of volatility implied by corn futures options with differing maturities, and evaluate its ability to predict subsequent realized price volatility. The implied forward volatilities anticipate realized volatility well.  For the nearby interval, the implied forward volatilities provide unbiased forecasts, and are superior to forecasts based on historical volatilities.  For more distant intervals, early-year options predict the direction and magnitude of future volatility changes about as well as a three-year moving average and better than a na´ve forecast.  However, later-year options display less forecast power in part due to reduced trading activity.

 

Frank, J.M. and P. Garcia.  (Forthcoming) “Time-Varying Premium?  Further Evidence in Agricultural Futures Markets.”  Applied Economics.

Abstract

Research has provided mixed results regarding the presence of a time-varying risk premium in agricultural futures markets. In this paper we test for the presence of a time-varying risk premium focusing on the properties of the underlying data. Our results show that accounting for the structural break in the 1970s plays a key role in the findings. In contrast to recent research, we find only limited evidence of time-varying risk premium. For a two-month horizon the corn, soybean meal, and hog markets show no signs of a risk premium, while very weak support for a time-varying premium emerges in live cattle. For the four-month horizon, no evidence of a time-varying risk premium appears for any of the markets.

 

Mattos, F., P. Garcia and C.H. Nelson. (Forthcoming) “Relaxing Standard Hedging Assumptions in the Presence of Downside Risk.”  Quarterly Review of Economics and Finance.

Abstract

We analyze how the introduction of a downside risk measure and less restriction assumptions in the standard hedging problem changes the optimal hedge and the opportunity costs of not hedging.  Based on a dataset of futures and cash returns for soybeans and S&P 500 returns, the findings indicate that the optimal hedge changes considerably when a one-sided risk measure is adopted and standard assumptions are relaxed.  Further, the results suggest that in a downside risk framework with realistic hedging assumptions there is little or no incentive for producers to hedge as the opportunity cost of not hedging is small.

 

Pennings, J.M.E., O. Isengildina, S.H. Irwin, P. Garcia, and W.E. Kuiper (forthcoming). “Producers’ Complex Risk Management Decisions”  Agribusiness:  An International Journal.  

Abstract

Producers have a wide variety of risk management instruments available, making their choice complex.  The ways producers deal with this complexity can vary and may influence the impact that the determinants such as risk aversion have on their choices.  A recently developed choice bracketing framework recognizes that producers are unable to evaluate all alternatives simultaneously and that to manage a complex task they often group or bracket individual alternatives and their consequences together in choice sets.  Data on 1,105 U.S. producers show that producers do not use all available combinations of risk management tools and that the influence of the determinants of producer’s risk management decisions are not necessarily the same across risk management strategies within and across bracketing levels.  The findings may help resolve puzzling results on the role that well-known determinants of risk management behavior have on producers’ choices, extending knowledge on producers’ risk management behavior.  Further the findings have managerial implications for policy makers and agribusiness companies that provide risk management services.

 

Kim, M.K., P. Garcia, and R.M. Leuthold (forthcoming). “Managing Price Risks using Futures Markets and Local Polynomial Kernel Forecasts.”  Applied Economics.

Abstract

This study contributes to understanding price risk management through hedging strategies in a forecasting context.  A relatively new forecasting method, nonparametric local polynomial kernel (LPK), is used to forecast prices and to generate ex ante hedge ratios.  The selective multiproduct hedge based on the LPK price and hedge ratio forecasts is in general found to be better than continuous hedging, no hedging and alternative forecasting procedures.  Selective multivariate hedging using the LPK is found to improve hog producer’s expected returns.  The findings indicate that combining hedging with forecasts, especially when using the LPK procedure, can improve price risk management.

 

Mattos, F., P. Garcia and J.M.E. Pennings (forthcoming). “Probability Distortion and Loss Aversion in Futures Hedging.”  Journal of Financial Markets.  

Abstract

We analyze how the introduction of probability weighting and loss aversion in a futures hedging model affects decision making. Analytical findings indicate that probability weighting alone always affects optimal hedge ratios, while loss and risk aversion only have an impact when probability weighting exists. In the presence of probability weighting, simulation results for a relevant range of parameter values suggest that probability weighting is dominant; changes in probability weighting affect hedge ratios relatively more than changes in loss and risk aversion. When decisions are made independently, loss aversion has a relatively small impact on hedge ratios for all parameter values and risk aversion becomes important for only a narrow range of risk coefficients which produce implausible speculative behavior. When prior losses and gains affect behavior, hedging is influenced most by prior outcomes that influence risk attitudes, but the effect is somewhat less than the effects of changes in probability weighting.

 

Frank, J., P. Garcia, and S.H. Irwin (forthcoming). “To What Surprises Do Hog Futures Markets Respond?” Journal of Agriculture and Applied Economics.

Abstract

We re-assess the effect of new information in the Hogs and Pigs Reports (HPR) focusing on rationality of announcements and alternative surprises. HPR announcements are irrational estimates of final estimates, and market expectations are irrational estimates of HPR numbers. Using the market’s best forecast and incorporating final estimates, we modify conventional information measures. Despite differences as large as 33 cents/cwt in price response, statistical findings suggest there is little to differentiate among the surprise measures. Regardless the message that HPR provides new information to the market is strongly supported.  On balance, marketing (breeding) information has a larger effect on short-term (long-term) price changes.

 

Woodard, J.D. and P. Garcia (forthcoming). “Basis Risk and Weather Hedging Effectiveness.” Review of Agricultural Finance.   

Abstract

Basis risk is cited as a primary concern for implementing weather hedges.  Using Illinois yields and related weather data, we investigate several dimensions of weather basis risk in the US corn market.  Results suggest that while geographic basis risk can be significant it should not preclude the use of geographic cross-hedging, particularly with temperature as opposed to precipitation derivatives.  Risk reduction is appreciable and the degree to which geographic basis risk impedes effective hedging diminishes as spatial aggregation in the risk exposure and hedging instrument increases.  Finally the presence of risk premiums can significantly erode the effectiveness of weather hedging.

 

Woodard, J.D. and P. Garcia (forthcoming). “Weather Derivatives, Spatial Aggregation and Systemic Insurance Risk:  Implications for Reinsurance Hedging.”  Journal of Agricultural and Resource Economics. 

Abstract

Previous studies identify limited potential efficacy of weather derivatives in hedging agricultural exposures.  In contrast to earlier studies which investigate the problem at low levels of aggregation, we find using straight forward temperature contracts that better weather hedging opportunities exist at higher levels of spatial aggregation.  Aggregating production exposures reduces idiosyncratic (i.e. localized or region specific) risk, leaving a greater proportion of the total risk in the form of systemic weather risk which can be effectively hedged using weather derivatives.  The aggregation effect suggests that the potential for weather derivatives in agriculture may be greater than previously thought, particularly for aggregators of risk such as re/insurers.