Cotton Hedging: A Comparison across Developing and Developed Countries

Qizhi Wang,Benaissa Chidmi

doi:10.4236/me.2011.24073

Abstract

This paper uses the results of ordinary least squares, bivariate vector autoregressive, and error correction models to estimate the hedge ratios for cotton production across different countries and to determine whether New York Cotton Exchange futures prices can serve as a hedging tool for cotton producers. Models comparison shows that the error correction model fits the data better. The results of the error correction model show that the spot prices and the NYCE futures prices are co-integrated in United States, Australia, and China, but not in Africa Franc Zone countries. In addition, for countries with higher market power, such as US and China, and countries without market distortions, such as Australia, the New York Cotton Exchange futures prices can serve as a hedging tool for cotton producers. In contrast, for less developed countries, such as Africa Franc Zone countries, and Pakistan, the NYCE futures prices cannot serve as hedging tool against the risks faced by cotton farmers.

Highlights

Cotton is one of the major natural fibers
This paper uses the results of ordinary least squares, bivariate vector autoregressive, and error correction models to estimate the hedge ratios for cotton production across different countries and to determine whether New York Cotton Exchange futures prices can serve as a hedging tool for cotton producers
For less developed countries, such as Africa Franc Zone countries, and Pakistan, the New York Cotton Exchange (NYCE) futures prices cannot serve as hedging tool against the risks faced by cotton farmers

Summary

Introduction

Cotton is one of the major natural fibers It accounts for around 40 percent of the world’s annual textile fiber production and serves as an engine of economic growth by providing income to millions of farmers in both developed and developing countries worldwide. The contribution of cotton to national gross domestic product (GDP) varies among countries. Cotton provides 3 to 5 percent of the GDP in Benin, Burkina Faso, Mali, and Chad. In Burkina Faso, Benin, Chad, Mali, and Togo, cotton export share in total exports represents 51.4 percent, 37.6 percent, 36.2 percent, 25 percent and 11.2 percent, respectively (Hussein, Hitimana, and Perret, 2005) [1]. The United States produces about 20 percent of the world’s cotton supply and consumes about 10 percent of world cotton. The importance of the cotton trade is evident in that much of the world’s cotton crosses international borders more than once before reaching its final consumers (MacDonald, 2000) [3]

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