Risk Hedging Mechanisms Research Articles

Weather risk hedging mechanism for contract farming supply chain with weather-dependent yield

The stability of contract farming is challenged by the impact of disastrous weather on crop yield. Managing weather risks has become an unavoidable reality for participants in contract farming. In this regard, this paper focuses on investigating weather risk hedging mechanisms for contract farming supply chain in a Newsvendor setting. As a benchmark, we first consider the agricultural production investment decision under the inherent mechanism (i.e. protective price mechanism) of contract farming. Due to the inevitable reduction of farmers’ agricultural investment levels and performance loss caused by disastrous weather under this mechanism, we then systematically propose innovative weather risk hedging mechanisms based on the completeness of both internal risk–benefit sharing mechanism of contract farming in developing economies and its external financial derivatives market. We define them as the operational weather risk hedging (OWRH), financial weather risk hedging (FWRH), and combined weather risk hedging (CWRH) mechanisms, respectively. The research findings are as follows: (1) The OWRH mechanism overcomes the distortion of agricultural investment levels and fosters a community of shared risks and benefits among contract farming participants, to reach the equilibrium with higher profits. Nevertheless, it falls short of externalizing weather risks. (2) The FWRH mechanism transfers disastrous weather risks encountered by contract farming and reverses the trend of decreasing performance as the disastrous weather intensify, yet it fails to resolve the distortion of agricultural investment levels and the internal distribution of profits among stakeholders. (3) The CWRH mechanism mitigates the distortion of investment levels and the decline of contract farming’s performance caused by intensifying weather disaster, improving the anti-risk capacity of contact farming. But it does not always contribute to the optimal profits for contract farming participants, instead, this achievement is only attainable in the face of severe weather. Meanwhile, it imposes higher requirements on the financial environment in developing economies. Furthermore, we provide distinct applicability boundaries for these weather risk hedging mechanisms. The aim is to provide valuable insights into the management of disastrous weather risks faced during the production process of contract farming supply chain in various regions of developing economies.

Price prediction of polyester yarn based on multiple linear regression model.

China's polyester textile industry is one of the notable contributors to national economy. This paper takes polyester yarn, core raw material in polyester textile industry chain, as research object, and deeply explores its price indicators and risk hedging mechanisms through multiple linear regression models and Holt-Winters approaches. It is worth mentioning that with continuous development of digital technology, digital transformation of production lines and warehouses has become an important development feature in various industries. This study also actively complies with this trend, and innovatively incorporates the upstream and downstream production line start-up rates into price prediction model. Through this initiative, we can more comprehensively consider the impact of supply and demand changes on price of polyester yarn, thus making prediction results more closely reflect the actual market situation. This quantitative analysis method undoubtedly provides new ideas for enterprises to better grasp market dynamics in digital era.

2008's mistrust vs 2020's panic: can ESG hold your institutional investors?

PurposeThe authors compare two market collapse incidents, focusing on their role as turning points for ESG considerations among investors that do not fall under the SRI class. The authors draw from the signaling theory to posit that ESG performance acts as a buffer to retain institutional shareholders under stress conditions.Design/methodology/approachThe authors collect extensive data on institutional shareholdings and corporate performance during the pandemic and the 2008 financial crisis to examine the potential of ESG to act as a downward risk hedging mechanism. The authors test whether superior ESG scores function as insurance and resilience signals that lock investors in through times of high probability of divestments.FindingsFindings indicate that ESG weighs in investment decisions during economic downturn and poor returns. The nature of this positive relationship is not static but dynamic contingent on overall risk materiality considerations.Research limitations/implicationsThe authors update regulators, firms, investors and academics on ESG, risk and crisis management. The shifting materiality and the altering impact of ESG practices is our core implication, as well as limitation, in terms of metrics, temporal evolution and interaction with institutional factors, along with portfolio alpha and safe haven potential in ESG asset classes.Originality/valueThe authors extend current literature focusing on portfolio returns and firm valuations to highlight the role of ESG in shareholder retention during poor return periods. The authors further add to existing studies by examining the shifting materiality of ESG pillars during different crisis settings.

Evolution laws and new trends of global LNG pricing and their implications

Natural gas is of great significance to ensuring China's energy security and achieving “carbon neutrality” by 2060. However, the lack of power to decide LNG import pricing and the high resource cost bring challenges to the stable supply of natural gas in China. In this regard, after analyzing the historical evolution laws of global LNG pricing, this paper systematically summarizes the pricing trends of newly signed contracts in 2020, and comparatively analyzes China's long-term LNG import pricing modes and its problems. And the following research results were obtained. First, the global LNG pricing mechanism is more diversified, regional characteristics and “Asian premium” problems are obvious, and different pricing mechanisms complement each other. Second, the newly signed long-term LNG agreement is linked with oil prices to play a dominant role again, and the oil-linked slope declines continuously and presents a dynamic mixed S-curve. Third, China's long-term LNG agreement is linked with oil prices at a high proportion, so there are no market conditions of gas–gas competition and the price review period is long. Finally, several suggestions were proposed for China's LNG import pricing. Firstly, stick to the principles of “short-term flexibility” and “long-term stability”, and make use of multiple modes comprehensively, e.g. gas–gas competition and Brent price linked, instead of completely decoupling oil prices. Secondly, referring to global newly signed contracts and Asian reviewed contracts, adhere to the principle of market parity, improve the price review terms and shorten the review period. Thirdly, the government shall support the construction of natural gas trading centers and futures markets and form the internationally recognized regional benchmark price as soon as possible. Fourthly, make a plan in advance, establish a risk hedging mechanism and control the overall cost of imported LNG resources.

Financial engineering to optimize risk management in banks based on Interest Rate Swaps to better hedge the exposure to interest rate fluctuations the case of banks in Syria

The banking system is affected by uncertainties related to the evolution of pandemic. One of the identified risks is that of a fluctuation of rates. Volatility of Interest rates is one of the major risks for the banking system. Therefore, financial engineering can be used as a very important hedging practice for banks against such a risk. The aim of this study is to develop a risk hedging mechanism to better overcome market volatility by hedging position against the exposure to interest rate risk based on credit derivatives. Therefore, this study uses Interest Rate Swaps (IRS)s to better hedge the exposure of banks to interest rate fluctuations in stress conditions giving consideration to the case study of banks in Syria in optimizing hedging practices based on Interest Rate Swaps. The aim is to use financial engineering to provide banks with a hedging technique to better absorb shocks in times of stress conditions. This has been discussed and illustrated with visual model diagrams. The case study of banks in Syria is not just the story of individual banks but a window into how to hedge the exposure of banks in stress conditions. In the end, most banking crises are quite similar. The recommendations set out in this study provide banks with an optimized hedging practice which is not part of current financial engineering at banks in Syria.

Development of an irradiance-based weather derivative to hedge cloud risk for solar energy systems

For large energy consumers transitioning to high shares of solar energy, irradiance variability causes volatility in power generation and energy expenditures. Volatility in an end user’s cash flow is harmful to their financial health, especially in abnormally cloudy years. This paper explores the utility of an irradiance-based weather derivative in mitigating cloud weather risk and measures the effectiveness of the developed derivative by applying it to a case study of two Chilean copper mines. Weather derivatives are financial instruments tied to an underlying weather variable that act as an insurance for the contract holder, executing indemnity payments based on an index value. This research develops a contract with a combined index based on monthly sums of irradiance and cloudy day sequencing to mitigate a solar mine’s weather risk. The design and evaluation of contracts are based on LEELO, a linear optimization model outputting optimal sizes of solar photovoltaic, battery storage, and power-to-gas systems, as well as the operation of these systems for a given mine’s load, irradiance and technology costs. Results indicate contracts are effective in cloudier climates with increasing utility for mines installing solar energy systems until the year 2030. After 2030 batteries begin to become a more cost-effective risk-hedging mechanism as they become more affordable.

Keeping Options Alive: Evidence from the Flat Panel Industry

In this paper, we reexamine the efficacy of redundant investment strategy and late entrance as a risk-hedging mechanism at the context of technological uncertainty, competition for an industry-wide dominance. Unlike recent findings against the effectiveness of such risk-hedging mechanisms, we identified a positive impact of dual investments by late entrants. In an early stage of a nascent industry when multiple (e.g. four or five) technologies competes, a dual investment strategy might not work. Later when the competition for dominance becomes a competition between two technologies, however, dual investments into the two technologies turns out effective. We also found that a business group structure contributes to managing complexity caused by dual investments. A semi-market structure institutionalized within a business group is effective in striking an optimal balance between internal competition and cooperation within the boundary of the firm.

Risk Hedging Tools: Efficiency and Significance of their Use in the Processes of Forming Development Strategies of Russian Oil and Gas Companies

The possibilities of using hedging methods as an instrument for effective business development in the Russian oil and gas market are shown. The relevance of the study is to systematize and identify the key elements of the risk hedging mechanism for business units of oil and gas companies. The focus is on the adaptation of methods such as descriptive statistics and the ARIMA model. Information for the study was taken from open sources, including daily data from company websites and data from official websites of other organizations. The article presents a risk hedging scheme in oil and gas field development projects. The risks of the project were assessed with qualitative and quantitative indicators. This made it possible to identify the dynamics of the degree of change in the latter and evaluate the costs associated with minimizing them during the life cycle of an investment project for the development of an oil (gas) field. Recommendations are proposed to reduce the basic risks of the project. To this end, they were ranked according to their importance to the investor. Significant risks in Russia for investors in the industry are country risks, the reduction of which is a priority for attracting new investments.

Designing risk hedging mechanism based on the utility function to help customers manage electricity price risks

Real-time pricing (RTP) is the most cost-effective retail tariff which transfers electricity wholesale market volatility to the electricity customers. Complexity and risk regarding market price volatility make many of the customers reluctant to contribute in RTP. In order to help customers manage electricity cost risk, this paper proposes the electricity retailer provides risk hedging contracts to cover RTP risks. Each customer compares these contracts and signs the most suitable one by selecting his/her desirable deductible level. The deductible is the highest price of the market that the customer is willing to pay for the electricity energy. When the market price exceeds the predetermined deductible, the retailer has to pay the difference between the market price and the deductible. In this paper, utility function is utilized to identify the customers’ preferences and behavior against different risk hedging contracts. To survey the performance of the proposed risk hedging mechanisms, three different utility functions are employed to study the impacts of the risk hedging contracts on the customers’ demand and electricity market price.

Heterogeneous risk preferences in community-based electricity markets

Organization in electricity markets is evolving from centralized pool-based to decentralized peer-to-peer structures. Within this decentralized framework, agents are expected to individually procure their energy, while directly negotiating with other market participants. Since distributed power generation is mostly based on non-dispatchable energy resources with zero marginal cost, any proposed decentralized negotiation mechanism needs to account for uncertainties. When operating uncertain assets, decision makers are affected by subjective attitudes towards uncertain payoffs, impacting not only their energy procurement but also the whole market equilibrium. We propose a new definition of fairness in risky environments and show that, in decentralized electricity markets, heterogeneous risk aversion of participants compromises fairness of the resulting market payments. Consequently, we introduce financial contracts as risk hedging mechanisms and evaluate their impact on market equilibrium and payments. We show that by trading financial products, fairness is restored.

. Mối quan hệ phụ thuộc giữa giá vàng và tỷ giá ngoại tệ ở Việt Nam

The linear relationship between gold price and exchange rate time series data is presumably based on the normal distribution assumption although this relationship is not always valid under the extreme market condition. This paper applied copula method to model the dependent relationship between gold price returns and USD/VND exchange rate under normal and extreme market conditions. The results showed that there was no dependent relationship between gold price and USD/VND exchange rate as well as gold was not a risk hedging mechanism for the fluctuation of USD/VND exchange rate in less volatile market condition. Meanwhile, gold was the safe haven for the USD/VND in the extreme fluctuation market. The results implied that a stable exchange rate and gold markets under highly volatile market conditions gold markets and exchange rate market should be integrated to allow investors to exploit hedging mechanism in one market to avoid risk in another.

Waning Public Support for International Cooperation? Some Lessons from Europe

The European Union (EU) is facing one of the rockiest periods in its existence. No time in its history has it looked so economically fragile, so unsure about how to protect its borders, so divided over how to tackle the crisis of legitimacy facing its institutions, and so under assault of Eurosceptic parties. While economic recovery may be on its way, at least in some member states, the Eurozone crisis has left a mark on popular opinion. Large parts of the public have come to doubt the competence and integrity of their political and financial masters in Brussels and at home. Existing approaches to public opinion towards supranational government in Europe, or international governance more generally, stress the role of economic interest and identity considerations (for an overview see Hobolt and De Vries 2016). These explanations also fit the narrative that has emerged in the media after Brexit, namely that the outcome constituted somewhat of a revolt of the left behind, those who failed to benefit from economic and political integration in Europe or more globally, against increased migration (Clarke et al. 2017; Goodwin and Heath 2016). Yet, the recent surge in Eurosceptic sentiment, expressed in European and national elections as well as in European referendums, is in many ways puzzling from both perspectives. Euroscepticism, for example, is most pronounced in countries that have weathered the Eurozone crisis very well and economically benefitted most from the single currency (Stiglitz 2016), while the support for the EU remains high in the bail-out battered South. Moreover, aggregate analyses of the Brexit vote suggest that poorer areas on average were more likely to vote out, but many deviations exist. Very rich areas in the South voted out. When it comes to identity considerations the empirical evidence is also at best mixed. While scholars expect people with an exclusive national identity to view an international organization like the EU as a threat, something that infringes on their sense of national belonging, feelings of exclusive national identity have remained remarkably stable in Europe over recent years or even declined in countries that witnessed stark increases in Euroscepticism (De Vries 2018). Opinions towards intra-EU migration and free movement also do not seem to uniformly account for the rise in Euroscepticism (Vasilopoulou and Talving 2017). In this contribution, I aim to shed light on these empirical puzzles. I suggest that one of the key reasons why Euroscepticism is widespread within comparatively richer countries and among those who are fairly well off is because wealth allows populations or individuals to consider more risky alternatives and makes the alternative state to membership, one’s country being outside the EU, look more viable. I present empirical evidence to my claims by using recent survey data from 28 member states. These findings point towards a possibly paradoxical process underlying international cooperation more generally, namely: the increasing monetary benefits associated with more economic and political cooperation across borders might over time become the risk-hedging mechanism that allows populations or individuals to turn against international governance in the long run.

Risk Assessment of Virtual Power Plants Offering in Energy and Reserve Markets

Distributed energy resources (DERs) can be integrated into a single entity, namely, virtual power plant (VPP). The integration enables them to participate in competitive wholesale electricity markets. According to the different types of uncertainty faced by different DERs, this integration can also act as a risk-hedging mechanism providing a surplus profit. In this paper, using a two-stage stochastic programming approach, risk-averse optimal offering model for a VPP trading in a joint market of energy and spinning reserve service is presented. The conditional value-at-risk (CVaR) is used to control the risk of profit variability. Uncertainties involved in generation of renewables, consumption of loads, calls for reserve service, as well as prices in the day-ahead market, the spinning reserve market (RM) and the balancing (real-time) market (BM), are taken into consideration. This paper assesses how total and surplus profits of VPP are affected by risk-aversion, participation in the RM, and the pricing system in the BM. For this purpose, the role of the integration and the trends of energy and reserve transactions under both single and dual pricing systems in the BM are addressed in detail through a numerical study.

Research on the Impact of Short Selling Mechanism on Investors’ Positive Feedback Trading Behavior

With the background of China’s Margin Trading pilot, the paper studies the effect of short selling mechanism on investors’ positive feedback trading behavior. The research results show that positive feedback trading behavior exists in Chinese stock market, and the launching of the short selling mechanism inhibits effectively the positive feedback trading behavior. Investors can show their pessimism towards the stock price by going short selling, thus the stock price can return quickly to the basic value. At the same time, leverage effect consists in the stock market, namely that investors react more strongly to bad news than to good news. After the implement of margin trading and short selling mechanism, the risk hedging mechanism increases, and investors in the market generally tend to react rationally to good news and bad news.

Downside Risk, Capital Flexibility and Operating Leases

In this paper, I investigate whether firms’ risk-hedging incentives affect their choices between owned and rented capital (operating leases). In recessions, firms facing negative demand shocks are loaded with unproductive capital. Absent of any trading frictions, firms can trade their assets to adjust their capacity in response to these shocks. However, due to costly reversibility of capital, firms might lack the flexibility to cut capital and deviate from their optimal investment. I find that the proportion of operating leased assets is positively correlated with downside risk. Furthermore, the relationship between operating leases and downside risk strengthens with firms’ inflexibility and the overall leverage in the industry. Finally, I show that contrary to conventional wisdom, by using operating leases, firms are able to reduce their risk exposure and expected return. My findings suggest that firms might be unwilling to retain the economic ownership of assets when, after an aggregate demand shock, the likelihood of being loaded with unproductive capital is high. As such, operating lease contracts might serve as risk-hedging mechanisms through which lessees transfer some of their operating risk to the lessor. These results suggest that, to some extent, companies use (and equity investors value) operating leases consistently with the economic interpretation underlying the “ownership approach” towards lease classification.

The global land rush: implications for agricultural communities.

Abstract Over the past decade, a host of interrelated and mutually reinforcing processes have stimulated a renewed interest in farmland in the global South. This has resulted in a growing trend in which long-term rights over customary land and natural resources are being acquired by corporations, investment funds and government agencies alike, either as an investment vehicle, risk hedging mechanism or economic asset. While the data on large-scale land acquisitions are notoriously slippery and hard to acquire (Edelman 2013), estimates place the scope of land acquisitions initiated since 2000 at between 38 million and 55.7 million ha (Land Matrix online database (http://www.landmatrix.org/en/ [accessed 19 October 2015])). Some have viewed these trends as an opportunity to secure much-needed investment in rural areas, in the anticipation of the benefits that will flow from it: employment, technological innovation, smallholder market integration and other positive social and economic spillovers. It has also been met with a critical response from other circles due to the risks posed to rural livelihoods, food and tenure security, the environment and self-determination. This paper reviews what is known about the implications of large-scale land acquisitions for agricultural communities in the global South, with a focus on Africa and on the (relatively limited) empirical work that has been done to shed light on a very polarized debate. Following a brief overview of the trends and drivers of the land rush, I review the evidence around some of the key themes defining this debate. The paper concludes with a brief discussion of implications for further research.

Impact of Deterioration and Negotiation on Sewer System O&M Contracts from the Real Option Perspective

Operation and maintenance (O&M) service contracts for water and sewer systems have increased considerably in the United States over the last 20 years. Successful O&M contract establishment requires a reasonable estimation of the O&M service contract coupled with a reliable risk-hedging mechanism, such as a ceiling agreement. Because the accurate valuation of an O&M contract is substantially influenced by the future O&M cost, which is subject to the future performance of the system, it is crucial that contracting parties develop realistic O&M cost scenarios based on a sound deterioration model. This study provides a real option-based methodology for the valuation of O&M contracts by modeling future O&M cost scenarios using deterioration models. Using sensitivity analyses, this study also investigates how surrounding conditions and negotiation options could affect the valuation of O&M contracts. The proposed methodology is expected to assist contracting parties in developing a fair and attractive O&M service contract.

Self-insurance of investor under repeating catastrophic risks

A decision-making problem of investment into a profitable object in a catastrophic risk area is considered. By a catastrophic risk is meant the probability of severe yet unlikely losses. As a risk hedging mechanism, an insurance fund is considered that is replenished by a part of profit and is used for object renewal. It is shown that methods of insurance mathematics can be used to assess the risk to lose the object. For the plant loss probability as a function of the insurance reserve, integral equations are derived. They can be solved by successive approximations.

RBI Autonomy and the Indian Financial Sector

In the context of the worldwide trend towards greater independence for the central banks and the recent public pronouncements by the Governor of the Reserve Bank of India (RBI), there is now a strong possibility of the RBI being given more autonomy. This is likely to be accompanied by several changes in the operations of the RBI including a pruning of its peripheral functions. This paper by Samir K Barua and Jayanth R Varma argues that these changes would have momentous implications for the financial system as a whole. Portfolio managers would have to contend with a wider choice of securities, more frequent portfolio rebalancing and use of risk hedging mechanisms. Corporate finance managers would face increased complexities in decisions like financing mix, cash management, designing financial instruments, capital budgeting and management of exchange risk.