The Hedging Role of Options and Futures under Joint Price, Basis, and Production Risk.

This paper analyzes the optimal production and hedging decisions for firms facing futures price, basis, and production risk, assuming futures and options can be used. Using constant absolute risk aversion utility and normal distributions, the authors derive an exact solution and show that joint production and price risk lead to a hedging role for options. Risk averse firms that can use each hedging instrument will generally have higher (expected) output. Using Iowa data for soybeans, the parameters of the joint distribution of future prices, cash prices, and yields are estimated and the results are used to approximate optimal hedging decisions for soybean producers. Copyright 1995 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.