Risk management and market conditions
2021
Abstract Using Commitments of Traders reports from commodity futures markets exchanges, hedging by commercial/merchants/producers' users are econometrically analysed to understand their relation to both commodity prices and commodity market volatility. Qualifying the body of literature which seeks to explain hedging activity as departures from Modigliani-Miller theory, market imperfections and transactions cost, we address the paradoxes of hedging which is not value creating and the absence of hedging when firms might benefit, arguing that it may be related to the market conditions and risk appetite. We discover that prices and volatility are generally statistically significant contributors to hedging activity by commercial/merchant/producers' users but with marked differences in their elasticities. For some commodities, price levels alone and not volatility are significant. We demonstrate that analysis of hedging should take cognisance of markets and the degree of risk aversion, otherwise the implicit assumption is that hedging is invariant to such matters. Through taking into account both market conditions and the degree of risk aversion, understanding the motivation for hedging may be facilitated.
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