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Determinants of Hedging and Risk Premia in Commodity Futures Markets

Published online by Cambridge University Press:  06 April 2009

David Hirshleifer
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Abstract

This paper examines the determinants of commodity futures hedging and of risk premia arising from covariation of the futures price with stock market returns, and with the revenues of producers. Owing to supply shocks that stochastically redistribute real wealth (surplus) between producers and consumers, and to limited participation in the futures market, the total risk premium in the model is not proportional to the contract's covariance with aggregate consumption. Stock market variability interacts with the incentive to hedge, causing the producer hedging component of the risk premium to increase (decrease) with income elasticity, for a normal (inferior) good. Production costs that depend on output raise the premium. We argue that output and demand shocks will typically be positively correlated, raising the premium. High supply elasticity reduces the absolute heding premium by reducing the variability of spot price and revenue.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 24 , Issue 3 , September 1989 , pp. 313 - 331
Copyright
Copyright © School of Business Administration, University of Washington 1989

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