THE HEDGING ROLE OF OPTIONS AND FUTURES UNDER JOINT PRICE, BASIS, ANDPRODUCTION RISK

This paper analyzes the optimal production and hedging decisions for f irms facing futures price, basis and production risk, assuming futures and options can be used. Using CARA (constant absolute risk aversion) utility and normal distributions, we derive an exact solution and sho w that joint production and price risk lead to a hedging role for opti ons. Risk averse firms that can use each hedging instrument will gener ally have higher (expected) output. Using Iowa data for soybeans, the parameters of the joint distribution of future prices, cash prices and yields are estimated and the results are used to approximate optimal hedging decisions for soybean producers.