Reference-Dependent Hedging: Theory and Evidence from Iowa Corn Producers. (27th June 2018)

• Record Type: Journal Article
• Authors: Jacobs, Keri L; Li, Ziran; Hayes, Dermot J
• Is Part Of: American journal of agricultural economics. Volume 100:Number 5(2018)
• Page Start: 1450
• Page End: 1468
• Publication Date: 2018-06-27
• Subjects: Expected utility -- forward contracting -- corn hedging -- production risk -- reference dependence -- subjective beliefs; Agriculture -- Economic aspects -- Periodicals; Agriculture -- Periodicals; 338.105
• DOI: 10.1093/ajae/aay035
• Languages: English
• ISSNs: 0002-9092

Abstract

Abstract: We develop a theoretical model of optimal hedging that nests expected utility and expected target utility theories. We use this model to characterize optimal hedging with and without reference price dependence. The model's theoretical predictions are tested with a unique database consisting of every forward contract written with a major grain marketing firm by Iowa corn producers over a five-year period. Our results suggest that a current December futures price higher than a reference price triggers hedging activity. A likely candidate for producers' reference price is a rolling average of the current futures price. We then use trading activity implied by the producers to determine if they benefit from the way they hedge. The evidence is mixed. Finally, we compare the producer forward contract data to the only publicly available data on producer hedging: The Commodity Futures Trading Commission Disaggregated Commitment of Traders Report (DCOT) for Short Hedgers. A hedge ratio constructed from the open interest in new futures contracts of the DCOT report is highly correlated with the producer hedge series in the Iowa data, providing evidence that DCOT data represent farmers' hedging behavior reasonably well. This work has important implications for future research that uses the DCOT data, and provides new evidence about producers' hedging behavior that marketing specialists and extension agents can use to enhance their educational efforts related to risk management.