STRATEGIC HEDGING FOR GRAIN PROCESSORS

Price risk management problems confronting grain processors differ somewhat from conventional motives for hedging. There are two components of this problem that are addressed in this study. One is the competitive characteristics of the processing sector, the structure and conduct of which ultimately determines the relationship between input and output prices. In some cases, these are highly correlated and in others they are not. The second refers to the hedge horizon, or, how far forward a firm should cover its inevitable short cash positions. This study incorporates these two components of hedging into a mean-variance framework to evaluate how they impact price risk management decisions for processors. A theoretical model is developed which is then solved numerically to illustrate the relationships between optimal hedge ratios, the correlation between input and output prices, and the hedge horizon. The model is applied to the case of the United States bread baking industry to further illustrate how these impact hedging in a particular industry.