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Hedging Effectiveness of Constant and Time-varying Hedge Ratios Using Futures Contracts: The Case of Ontario and Alberta Feedlot Industries

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Title: Hedging Effectiveness of Constant and Time-varying Hedge Ratios Using Futures Contracts: The Case of Ontario and Alberta Feedlot Industries
Author: Ai, Di
Department: Department of Food, Agricultural and Resource Economics
Program: Food, Agriculture and Resource Economics
Advisor: Hailu, Getu
Abstract: This thesis demonstrates that optimal hedge ratios using futures contracts for Ontario and Alberta feedlot operators were low for live cattle and feeder cattle, and shows that the risk reduction from using US based live and feeder cattle futures was lower than 30% in most cases. Abstracting from the mean variance theoretical framework, constant optimal hedge ratios were estimated using OLS and SUR models. Time-varying optimal hedge ratios were estimated by GARCH models and the rolling window technique. Hedging effectiveness was measured by the variance reduction of hedged portfolios compared with a no-hedging position. Results suggested that hedging in the CME futures market reduced corn price variation by more than 50%. However, the optimal hedge ratios for cattle and barley in general were found to be low. Results also indicated that time-varying hedge ratios eliminated more risk than constant hedge ratios at the cost of frequently adjusting hedging positions. Higher optimal hedge ratios were obtained in the pre-BSE period than in the post-BSE period in both the commodity market and the currency market for joint hedging live cattle and the exchange rate. Both time-varying hedging and joint hedging strategies may generate additional transaction costs, which have negative impacts on the benefit from the potential higher risk reduction.
URI: http://hdl.handle.net/10214/3868
Date: 2012-08
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