Optimal Hedging Strategies for the U.S. Cattle Feeder

Abstract

Multiproduct optimal hedging is compared to alternative hedging strategies as applied to a Midwestern cattle feeder. One-period feeding margin hedge ratios are estimated using weekly cash and futures price data from a simulation of a custom feedlot for 1983-1995. Hedge ratios are estimated using the last 4 years, 6 years, or all prior data available at the moment of estimation; the ratios demonstrate less variability as the length of the underlying sample increases. Hypothesis of all hedge ratios being equal to each other, that leads to the proportional hedging model, is rejected. Means and variances of hedged feeding margins using the computed hedge ratios suggest that there is no consistent domination pattern among the alternative strategies. For the ratios computed based on all prior data available, all strategies are on the efficient frontier, leaving the hedging decision up to the agent's degree of risk aversion. All hedging strategies are shown to significantly reduce the feeding margin's means and variances compared to no hedging, with variance reduction always exceeding 50 percent. Whether a producer chooses multiproduct, single-commodity, or proportional hedge ratios is sensitive to the data set and its size.