Conditional feeder cattle hedge ratios: Cross hedging with fluctuating corn prices

Abstract

Feeder cattle are a heterogeneous commodity whose prices differ in important ways relative to the cattle specified in the CME Group Feeder Cattle futures contract. This necessitates estimation of optimal feeder cattle hedge ratios to manage price risk. Corn price is an important and often overlooked consideration when estimating feeder cattle hedge ratios. Corn price impacts feeder cattle weight-price slides and associated hedge ratios, which can result in over- or under-hedging. Utilizing transaction data from four feeder cattle markets, we estimate hedge ratios conditioned on corn price and compare risk of using corn-conditioned hedge ratios to using hedge ratios not dependent on corn price. Feeder cattle hedge ratios vary substantially across time, sex, location, and weight, which necessitates more frequent and detailed hedge ratio estimation. However, hedging risk is not generally statistically or economically significantly reduced by using corn-conditioned hedge ratios.