Optimal Multiple Crop Price Hedging: Robust Estimates Under Yield/Basis Risk

Abstract

This paper examines how commodity futures can optimally be used by farmers to reduce exposure to price risk in the presence of production uncertainty. The multiple-crop hedging problem is modeled under conditions of price risk, production risk, and basis risk. The results are of general significance for producers with concave utility functions of expected wealth.

Optimal hedges are obtained that are quantitatively robust for different wealth levels and for variations in utility functions spanning the plausible range from decreasing to increasing relative risk aversion and for relative risk aversion coefficients of any plausible value.

Extensions to the existing literature include a closed form solution that provides robust estimates of optimal hedging strategy for the multiple crop hedging problem under uncertain yields, estimation of the optimal hedge variation as a function of distance from the geographical center of crop production, and optimal hedge estimates for state average crop mixes by state for forty-two states.