Price Risk Management Research Articles

The Relationship between Fuel and Food Prices: Methods, Outcomes, and Lessons for Commodity Price Risk Management

We review the fuel-food price linkage models of the time series, structural, and general or partial equilibrium nature with the main attention devoted to the time series literature. Our assessment is nested in the discussion of general commodity prices co-movement on one side and in the prediction of most likely development of biofuel policies and production development on the other side. We pay particular attention to financial markets relevant features of commodity price co-movement significant for price risk management. We show that indeed the introduction of significant biofuels policies around 2005 increased the price transmission between fossil fuels and food commodities with intuitively expected prevailing leading role of fuel prices over food prices and with particular price linkages dynamically evolving in time and depending on the particular market under consideration. The econometric results show that due to the policy induced trade barriers, there is no evidence of sufficiently integrated international biofuels market with the US, European and Brazilian markets and policies following separate paths.

Forecasting of Tomatoes Wholesale Prices of Nairobi in Kenya: Time Series Analysis Using Sarima Model

Price forecasting is more sensitive with vegetable crops due to their high nature of perishability and seasonality and is often used to make better-informed decisions and to manage price risk. This is achievable if an appropriate model with high predictive accuracy is used. In this paper, Seasonal Autoregressive Integrated Moving Average (SARIMA) model is developed to forecast price of tomatoes using monthly data for the period 1981 to 2013 obtained from the Ministry of Agriculture, Livestock and Fisheries (MALF) in the agribusiness department. Forecasting tomato prices was done using time series monthly average prices from January 2003 to December 2016. SARIMA (2, 1, 1) (1, 0, 1)12 was identified as the best model. This was achieved by identifying the model with the least Akaike Information Criterion. The parameters were then estimated through the Maximum Likelihood Estimation method. The time series data of Tomatoes for wholesale markets in Nairobi are considered as the national average. The predictive ability tests RMSE = 32.063, MAPE = 125.251 and MAE = 22.3 showed that the model was appropriate for forecasting the price of tomatoes in Nairobi County, Kenya.

Hedging, speculation, and risk management effect of commodity futures: Evidence from firm voluntary disclosures

Using the dichotomy distinction idea from the International Financial Reporting Standards, the study proposes a new method to distinguish hedging from speculation based on firms' voluntary disclosures of hedging activities. Accordingly, we categorize commodity futures in Chinese non-financial listed firms into hedging and speculation and find that the price risk management effect of commodity futures is only attributed to the hedging part. To be more precise, using commodity futures for hedging can reduce firms' significantly higher price risk exposures into a slightly lower level. On the contrary, using commodity futures for speculation affects little on firms' price risk exposures. These findings shed light on the underlying channels for the price risk management effect of commodity futures in the real economy.

Price risk management in BOT railroad construction projects using financial derivatives

PurposeRailroad transit infrastructures are amongst major capital-intensive projects worldwide, which impose significant risks to the contractors of build-operate-transfer projects because of the fluctuations in steel price fluctuation. The purpose of this paper is to introduce a methodology for hedging steel price risk using financial derivatives.Design/methodology/approachCox–Ross valuation lattice has been used as an option valuation model for determining option’s price for the construction companies involved in fixed-price railroad projects. A sensitivity analysis has been conducted using the financial option Greeks to evaluate the impacts of option’s pricing factors in the total price of option.FindingsThe result of valuation shows that European options cost to safeguard against the effects of price risk is only a fraction in contrast to the total cost of steel procurement for a typical railroad construction company. This confirms that using this kind of financial derivative is a beneficial yet effective approach for hedging steel price risk for railroad construction companies.Practical implicationsThe applicability of the financial derivatives, both exchange-traded and over-the-counter instruments, is evident in broad financial industry. This paper shows how European options can be readily used for risk management of a typical railroad project, and explains the methodology in a step-by-step procedure.Originality/valueAlthough the financial engineering literature is rife of theory and application of derivatives in various contexts, to the best knowledge of authors there is only few papers on the application of these well-developed financial instruments for risk management in construction industry. This study intends to illustrate how financial derivatives can add value to risky construction projects and shed new light in this important application area.

Selected methods of securing the refining sector against crude oil price fluctuations

Abstract The contemporary refining sector has to contend with many types of risks, among which price risk is considered to be the foremost. Moreover, refineries define it as a commodity risk and identify it with both opportunities and threats carried by changes in prices of crude oil and products of refining. In this paper, we present selected methods that may protect enterprises in the refinery sector from the consequences of rapid fluctuations in oil prices. The focus is mostly on the opportunities offered by commodity options. Skillful combination of the above-mentioned derivatives in optional strategies enables hedging of the purchase prices of raw materials within fixed price ranges. In order to examine the effectiveness of using these strategies, the parameters of the commodity options from the New York Mercantile Exchange are utilized. The analysis of the West Texas Intermediate (WTI) crude oil prices covers the period from June 2014 to March 2018. Three different strategies from the vertical spread group have been taken into consideration, namely, short butterfly spread, long strip, and long strap. European call and put options with different strike prices have been used in the construction of these strategies. The comparison of the results achieved in the research indicates that there is an answer to the question of strategies that ought to be used at various levels of oil price changes. Moreover, the empirical results reveal that during rapid fluctuations in crude oil price (<10% month on month [MOM]), the median of most variants (80%) for the three considered strategies was positive. Furthermore, 70% of variants gave positive results, with price changes between 5% and 10%, whereas for price fluctuations of >5%, the strategies turned out to be an ineffective protection. The best results with rapid fluctuations in oil prices were obtained in the long strip strategy. Additionally, increasing the exercise price of options used in this strategy improved the mean for the final results. The higher exercise prices of the options also resulted in greater sensitivity of the effectiveness of the long strip strategy on the level of changes in oil prices. For the strategy variant with the At The Money (ATM)+10% options, the Pearson’s correlation coefficient between the final result and the WTI oil prices in the analyzed period amounted to –0.91. For variants with the ATM+5% and ATM options, the value of this coefficient was –0.85 and –0.71, respectively. It is also worth noting that the consequence of increasing strike price in the long strip strategy was higher standard deviations for the final results. The empirical results might be useful information for oil refineries. It can help refineries to create a more successful price risk management policy, which may thus protect the companies from the negative consequences of unfavorable crude oil price movements.

Commodity futures with thinly traded cash markets: The case of live cattle

Negotiated cash markets have thinned in many commodities over time as alternative marketing agreements have become increasingly prominent. Thinning cash markets challenge information which facilitates price discovery for both cash and futures markets. The US live cattle cash market has experienced a substantial structural shift toward non-cash market trade in recent years leading to sporadic trade across market regions that appear at times to be segmented markets. At the same time, the cattle market has realized immense price volatility making judicious price risk management by producers essential. However, hedging risk has also increased. This article illustrates the nature of changes affecting hedging effectiveness in light of thinning cash markets in fed cattle and discusses a variety of actions that have been considered to try to mitigate concerns.

An Analysis of Problems and Constraints Faced by Farmers in Marketing of Agricultural Produce in Punjab

Agriculture as an economic activity is subjected to serious risk of natural conditions and price risk. Some of the important constraints of agricultural marketing system in the country are lack of infrastructure like storage, transportation, quality control, packaging, price risk management, cool chains, market led extension, and condusive framework for promotion of contract farming. The present study was undertaken in the state of Punjab to study the problems of farmers in the marketing of paddy, wheat, maize and cotton. A total sample of 180 farmers from 12 villages of six districts was selected for the study. The sample farmers were further categorized, based on their operational holding, as marginal, small, semi-medium, medium and large farmers. The results from the study indicated that the most important problem identified by the farmers in the marketing of paddy and wheat was the delay in procurement of paddy in the markets followed by the deduction of payments by commission agents due to higher moisture content in the grains. However, the major problem during marketing of basmati was the exploitative practices by the intermediaries followed by lack of public procurement. The problem faced by majority of farmers in the marketing of maize and cotton was the lack of public procurement of the produce and lack of remunerative price of the crop respectively.

Aditya Birla Money: developing options of investment strategy

Subject area Financial derivative and risk management. Study level/applicability The case is intended to be used for MBA and BBA programs in the elective courses such as derivatives and risk management, financial engineering, financial risk management and portfolio management, and for executives aspiring for the fund manager position in industry. The case could also be used in management development programs on financial risk management. Case overview The case was based on the real life experience of a portfolio manager who was entrusted with the responsibility of maximizing return of the portfolio. With the backdrop of dismal performance of the portfolio, the portfolio manager is looking for opportunity in the context of declaration of result by Infosys Ltd, one of the constituents of the portfolio. So the team headed by Nirakar Chaulia was thinking of development and application of option strategies to exploit the result day (i.e. January 14, 2016) opportunity to improve the performance of the portfolio and also reduce the potential of stock price risk. Moreover, the case was designed to help the students develop and assess different option strategies based on their market intuitions. Also, students would be able to apply the option contracts for managing price risk associated with the underlying asset. Expected learning outcomes The case would prepare students to develop different strategies to be exploited in different market conditions and assess their performance. Especially, this case was designed to enable the students to understand options as a special kind of derivative in terms of trading and its payoff, how to initiate directional and volatility trading with options, how to apply options to generate income to enhance the portfolio performance and how to develop option strategies for different market conditions and assess their performance. Supplementary materials Teaching note is available for instructors only. Subject code CSS 1: Accounting and Finance.

Barndorff-Nielsen and Shephard model: oil hedging with variance swap and option

In this paper the Barndorff-Nielsen and Shephard (BN-S) model is implemented to find an optimal hedging strategy for the oil commodity from the Bakken, a new region of oil extraction that is benefiting from fracking technology. The model is analyzed in connection to the quadratic hedging problem and some related analytical results are developed. The results indicate that oil can be optimally hedged with the use of a combination of options and variance swaps. Theoretical results related to the variance process are established and implemented for the analysis of the variance swap. In this paper we also determined the optimal amount of the underlying oil commodity that has to be held for minimizing the hedging error. The model and analysis are used to numerically analyze hedging decisions for managing price risk in Bakken oil commodities. From the numerical results, a number of important features of the usefulness of the Barndorff-Nielsen and Shephard model are illustrated.

Price volatility and risk management of oil and gas companies: Evidence from oil and gas project finance deals

We investigate how the oil and gas project companies' decisions to hedge the risk of future prices of oil and gas respond to the changes in the price volatility of oil and gas, especially the role of the exposure of the sponsor company's stock returns to the risk of oil and gas prices. With a sample of 328 loans made to oil and gas development projects in 30 countries during 1996–2011 period, we find that the oil (or gas) price volatility increases the oil (or gas) project company's hedging likelihood, especially to a greater extent for the case in which the sponsor company's oil (or gas) exposure is smaller. Our findings suggest that the sponsor company's willingness to reduce its exposure to the risk of oil and gas prices increases the likelihood that the subsidiary project company will hedge the risk of future prices of oil and gas.

A credibility-based yield forecasting model for crop reinsurance pricing and weather risk management

PurposeThe purpose of this paper is to propose an improved reinsurance pricing framework, which includes a crop yield forecasting model that integrates weather variables and crop production information from different geographically correlated regions using a new credibility estimator, and closed form reinsurance pricing formulas. A yield restatement approach to account for changing crop mix through time is also demonstrated.Design/methodology/approachThe new crop yield forecasting model is empirically analyzed based on detailed farm-level data from Manitoba, Canada, covering 216 crop varieties from 19,238 farms from 1996 to 2011. As well, corresponding weather data from 30 stations, including daily temperature and precipitation, are considered. Algorithms that combine screening regression, cross-validation and principal component analysis are evaluated for the purpose of achieving efficient dimension reduction and model selection.FindingsThe results show that the new yield forecasting model provides significant improvements over the classical regression model, both in terms of in-sample and out-of-sample forecasting abilities.Research limitations/implicationsThe empirical analysis is limited to data from the province of Manitoba, Canada, and other regions may show different results.Practical implicationsThis research is useful from a risk management perspective for insurers and reinsurers, and the framework may also be used to develop improved weather risk management strategies to help manage adverse weather events.Originality/valueThis is the first paper to integrate a credibility estimator for crop yield forecasting, and develop a closed form reinsurance pricing formula.

Managing Price Risk in the Corn Market Using Option Strategies

In today’s economy, the agricultural sector faces a high degree of risk due to increasing commodity price volatility. Therefore, it is important to know how to manage the price risk effectively. The main contribution of the paper is to introduce and analyse the ways of the managing price risk in the corn market using option strategies. The purpose of the paper is to analyse three hedging option strategies, i.e. Strap, Long Strangle and Short Put Ladder strategy with the aim to prove how it is possible to hedge against falling prices. There is examined analytical expressions of vanilla options for the creation of selected hedging strategies in the corn market with the presentation of their pros and cons. General expressions of the corn selling price intervals are derived from various hedged scenarios of all variants. Based on derived theoretical hedging variants, the contribution of the approach is considered for the application to the corn market, where the corn options on futures contracts are traded on the Chicago Board of Trade. Also, the evaluation of the sellers’ profitability is examined at the future trade date. Finally, a comparative analysis of the proposed hedging techniques with the various strike prices is displayed with the presentation of recommendations for potential corn sellers. The paper’s aim is to extend the previous research based on different hedging tools and it may be widened in the scientific and the commercial area.

Asymmetric impacts of disaggregated oil price shocks on uncertainties and investor sentiment

This paper aims to examine short- and long-run asymmetries in the impacts of disaggregated oil price shocks on economic policy uncertainty, stock market uncertainty, treasury rates, and investor (bullish and bearish) sentiment in the US. To this end, we use a nonlinear auto-regressive distributed lag cointegration approach, which allows us to capture both positive and negative disaggregated oil shocks. We find that oil demand shocks are the main drivers of both measures of uncertainty, while oil supply shocks affect treasury rates. However, both oil demand shocks and oil supply shocks affect investor sentiment, with certain differences in the effects of positive and negative shocks. The overall effects of both oil demand and supply shocks—whether positive or negative—are stronger in the long-run than in the short-run. Additionally, we apply rolling causality and reveal evidence of a rather homogenous causal flow from disaggregated oil shocks to the variables studied, particularly around global stress periods. Our findings have implications for asset pricing and portfolio risk management and suggest policy formulations that differentiate between disaggregated positive and negative oil price shocks.

Price level targeting and risk management

The desirability of a nominal-level target during zero lower bound (ZLB) episodes has become a relevant topic for central bankers and academics. In such a context, this article studies the effects of uncertainty about the future state of the economy on the performance of strict-price-level targeting versus nominal-GDP-level targeting. These targeting frameworks are compared in a small New Keynesian model, which offers a clear illustration of the tradeoffs faced by the central bank. The analysis shows that uncertainty about the future hampers economic performance to a greater extent under nominal-GDP-level targeting, relative to strict-price-level targeting. The reason is that strict-price-level targeting induces greater policy inertia and, therefore, improves the tradeoffs faced by the central bank during ZLB episodes.

Futures trading of maize in India:A tool for price discovery and risk management

Futures trading of maize in India:A tool for price discovery and risk management

Financialization and Global Commodity Chains: Distributional Implications for Cotton in Sub‐Saharan Africa

ABSTRACTRestructuring of global and local markets has led to an increased influence of commodity derivatives markets on commodity price setting. This has critical implications for price risks experienced by actors along commodity chains. Commodity derivatives markets have undergone significant changes that have been referred to as the ‘financialization of commodities’, which we define as an increase in trading activity by financial investors and the reorientation of business strategies by commodity trading houses towards risk management and financial activities. This article assesses how these global financialization processes affect commodity producers in low‐income countries via the operational dynamics of global commodity chains and national market structures. It investigates how prices are set and transmitted and how risks are distributed and managed in the cotton sectors in Burkina Faso, Mozambique and Tanzania. It concludes that uneven exposure to price instability and access to price risk management have important distributional implications. Whilst international traders have the capacity to deal with price risks through hedging, in addition to expanding their profit possibilities through financial activities on derivatives markets, local actors in producing countries face the challenge of increased short‐termism — albeit to different extents depending on national market structures — with limited access to risk management.

Price and market risk reduction for bond portfolio selection in BRICS markets

This paper focuses on classical portfolio strategies applied to five countries, which are Brazil, Russia, India, China and South Africa. These five countries form the so-called BRICS group. In particular, the authors investigate their corporate and sovereign bond market and evaluate whether these markets can represent a profitable investment for non-satiable and risk-averse investors. Two-step optimization is proposed to control price risk and market risk. For price risk management, classical immunization strategies and are obtained funds of bond are obtained that share the same risk measure. For market risk control, the previously found funds are used and a performance measure optimization commonly used in stock markets is applied to define the best portfolio of funds. Therefore, the resulting optimal portfolio controls the price risk and jointly maximizes a desired performance measure that includes the market risk. Finally, the authors propose an empirical analysis to evaluate the profitability of the suggested two-step optimization for the five BRICS countries and compare the ex-post sample paths of the obtained portfolios for testing the stochastic dominance relations.

Price risk management using forward contracts: the case of farmers in Pakistan

Farmers have limited control over the market and commodity prices that cause price risks and uncertainties. To manage these risks, farmers adopt several risk management tools, and forward contract is one of them. The aim of this study is to find out the important factors that influence the adoption of forward contract as risk management strategy and problems associated with it. The selected study area is Mardan District in Pakistan. Primary data was collected from 168 farmers through survey and in-depth interviews. Probit model was used to determine the factors influencing farmers' adoption of forward contracting as a risk management strategy. The empirical results showed that age, education, landholding size, risk perception of price, risk attitude and access to formal sources were significant factors influencing the adoption of forward contracting. The results also revealed that medium and large subsistence farmers adopted forward contracting more than small subsistence farmers.

Ocena zastosowania zagranicznych kontraktów terminowych w zarządzaniu ryzykiem cenowym na rynku pszenicy w Polsce

Ocena zastosowania zagranicznych kontraktów terminowych w zarządzaniu ryzykiem cenowym na rynku pszenicy w Polsce

Avaliação de eficiência de estratégias de hedge para o risco de preço do café do Brasil com o uso de contratos da BM&FBOVESPA

Brazil is the world’s largest coffee producer and exporter. However the new prices and volatility scenario since the 2008 crisis and the increasing competition of new players entry have expressed the need for use of market mechanisms for managing price risk. Among the alternatives illustrated are the futures markets, in particular the coffee futures contracts at BMFBOVESPA, Brazil. Our aim was to evaluate the efficiency of no hedge, simple (naïve) hedge, static and dynamic hedge calculated by GARCH-BEKK strategies in managing price risk in the leading Brazilian coffee producing regions. The efficiencies of static and dynamic hedging strategies were superior to the other, although the latter allows the calibration of intertemporal hedging rates, reducing operational costs. Also, the use of BMFBOVESPA coffee futures contracts for hedging might increase market liquidity, enabling various operational alternatives design.