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Profit Margin Hedging

Some extension economists and others often recommend profit margin hedging in choosing the
timing of crop sales. This paper determines producerâ€™s utility function and price processes
where profit margin hedging is optimal. Profit margin hedging is shown to be an optimal
strategy under a highly restricted target utility function even in an efficient market. Although
profit margin hedging is not the optimal rule in the presence of mean reversion, it can still be
profitable if prices are mean reverting. Simulations are also conducted to compare the expected
utility of profit margin hedging strategy with the expected utility of other strategy such as always
hedging and selling at harvest strategies. A variance ratio test is conducted to test for the
existence of mean reversion in agricultural futures prices process. The simulation results show
that the expected utility of profit margin hedging strategy is highest. The paired difference tests
for the profit margin hedging and other two strategies shows that the expected utilities of profit
margin hedging strategies are not significantly different from those of always hedging strategy,
but are significantly different from those of selling at harvest strategy except when the
transaction cost is considered. The results of variance ratio test indicate that there is little
evidence that futures price of wheat follows mean reverting process.

Publication Type:

Conference Paper/ Presentation

Record Identifier:

https://ageconsearch.umn.edu/record/37570

PURL Identifier:

http://purl.umn.edu/37570

Record created 2017-04-01, last modified 2018-01-22