Financial Hedging and Optimal Procurement Policies Under Correlated Price and Demand

Posted: 16 May 2013

See all articles by Ankur Goel

Ankur Goel

Case Western Reserve University - Weatherhead School of Management

Fehmi Tanrisever

Bilkent University, Faculty of Business Administration

Date Written: May 16, 2013

Abstract

We consider a firm that procures an input commodity to produce an output commodity to sell to the end retailer. Retailer’s demand for the output commodity is negatively correlated with the price of the output commodity. The firm can sell the output commodity to the retailer either through a spot or a forward contract. Input and output commodity prices are also correlated and follow a joint stochastic price process. The firm maximizes the value of its stakeholders by jointly determining the optimal procurement policy of the input commodity, and the financial hedging policy for the sales of the output commodity. We show that partial hedging dominates both perfect hedging and no-hedging when input price, output price, and demand are correlated, and we characterize this optimal hedging policy. We identify sufficient conditions under which myopic policy is optimal for the price taking firm. We also show that expected base-stock policy is optimal in the presence of yield uncertainty. Our analysis illustrates that hedging is most beneficial when output price volatility is high and input price volatility is low. Our model is tested on the futures price data between 4/1/2005 to 12/31/2011 from Chicago Board of Trade (CBOT) for corn and ethanol.

Keywords: Hedging, Inventory, Yield Uncertainty, Myopic Optima

Suggested Citation

Goel, Ankur and Tanrisever, Fehmi, Financial Hedging and Optimal Procurement Policies Under Correlated Price and Demand (May 16, 2013). Available at SSRN: https://ssrn.com/abstract=2265942 or http://dx.doi.org/10.2139/ssrn.2265942

Ankur Goel (Contact Author)

Case Western Reserve University - Weatherhead School of Management ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States

Fehmi Tanrisever

Bilkent University, Faculty of Business Administration ( email )

Bilkent
Ankara, 06800
Turkey

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