Abstract
AbstractThe feeder cattle futures contract has been criticized in recent years as not providing an effective hedging instrument. Following historically volatile cattle markets in 2014–2015, feeder cattle basis risk escalated, fueling futures contract concerns. This study assesses these concerns, utilizing weekly auction data from 32 feeder cattle markets from 1992 to 2021. Examined for the first known time, feeder cattle market variation had a statistically and economically significant influence on basis risk. Basis variation differed across regions and marketing periods. Feeder cattle basis risk was historically high in 2014–2015 but declined to levels similar to 2011 by 2018.
Highlights
In the presence of notable market uncertainty, the CME Group Feeder Cattle Futures contract facilitates risk transfer from commercial users managing price risk to speculators seeking to profit from market volatility
The risk transfer function is a necessary component of any futures contract, and the performance and use of a contract determines its viability as a risk management tool
Basis predictability is essential for hedgers using the feeder cattle futures contract as a price risk management tool
Summary
In the presence of notable market uncertainty, the CME Group Feeder Cattle Futures contract facilitates risk transfer from commercial users (hedgers) managing price risk to speculators seeking to profit from market volatility. The risk transfer function is a necessary component of any futures contract, and the performance and use of a contract determines its viability as a risk management tool. Dramatic price swings in U.S cattle markets during 2014–2015 prompted concerns over the effectiveness of cattle futures contracts as hedging instruments (National Cattlemen’s Beef Association, 2016; Schroeder, Tonsor, and Coffey, 2019). As a thinly traded contract relative to live cattle futures (Bina and Schroeder, 2019), concerns were exacerbated for feeder futures. Peel (2020) argued “Feeder futures have become increasingly volatile in ways that often appear unrelated to market fundamentals. Erratic futures price movements and increased basis volatility makes it difficult or impossible for the industry to use feeder futures for its two primary roles of risk management and price discovery.”
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