Hedging Strategies under Market and Weather Uncertainties for Ontario Crops
Farmers make numerous decisions about what to produce, what production techniques to use, how many to plant, and when and where to buy inputs and sell outputs. Meanwhile, farmers face market and weather risks that can impact their net income. In this study, I examine the use of derivative markets as a tool for managing price and weather risks. First, I use the Mean-Variance theoretical model to examine the relationship between yield variability, price expectation, yield expectation and optimal hedge ratio. Second, I estimate optimal hedge ratio for corn, soybeans, and wheat using Ordinary Least Square, Error Correction Model, and the Generalized Autoregressive Conditional Heteroscedasticity. Results reveal that optimal hedge ratios are low for each crop, yield variability and price expectation are inversely related to optimal hedge ratios, and crop yield expectation is positively related to optimal hedge ratios. These findings have important implication for risk management, policy, and welfare.