Research On Price Risk Management In Commodity Supply Chain Finance

Commodity supply chain finance is financing services provided by financial institutions for industrial entities in a commodity supply chain in order to enhance their cash flow efficiency and to achieve higher turnover rate.There are two types of financing service,advance payment financing and inventory financing,in commodity supply chain finance,which have many sub-types according to different procedures or participants.Both of these two financing services belongs to movable property mortgage loan.A financial institution would have to deal with many types of risk as soon as it starts to provide movable property mortgage loans with commodity as collaterals.Price risk is the most important risk among all these types of risk.Price risk means the possibility that the price of the commodity as a collateral will fall.Price drop would devalued the collateral,making its value less than the value of the mortgage loan principal plus interest.Under this circumstance,the debtor would be more likely to default,and the financial institution have to wind up all the devalued collateral and take a loss.Setting a suitable loan-to-value ratio(LTV ratio)is an important measure to control the price risk in commodity supply chain finance.How to set up a suitable LTV ratio according to the price risk?We make an effort to solve this problem.We make two mathematical models,an exogenous default model and an endogenous default model,to unveil the link between price risk and LTV ratio.Both of these two models suggest that a higher level of price risk would lead to a lower LTV ratio.With the mathematical model between price risk and LTV ratio being made,the next step of study price risk measurement.Based on financial institution's risk control conditions in the exogenous default model,value-at-risk(VaR)is the most suitable method to measure price risk.In the case that there is only one type of commodity as collateral,we use GARCH model and estimate the distribution function of the commodity's prices and use this estimated function to calculate VaR.In the case there are multiple types of commodities as collateral,we use GARCH model and estimate the marginal distribution function of each commodity's price,then we use Copula function and the estimated marginal distributions to fit the joint distribution function,which can be used to calculate VaR.A number of commodities' historical prices are use in this paper to test the proposed risk measuring methods,including GARCH model and Copula function estimation and VaR estimation as well as robustness tests.These tests shows that VaR is a suitable risk measurement.With VaR it is easy to calculate LTV ratio.Based on the endogenous default model,an mortgage loan with commodity as collateral could be decomposed into a fixed-income risk-free asset and a short put option.Therefore,the price risk of the loan comes from the short put option.To manage price risk of the loan is to manage the risk of the put option.This paper suggest the usage of commodity futures and options contracts to hedge the risk of the put option.We propose several risk-hedging strategies,and use Monte Carlo sampling technique to verify these them.Based on these analysis,we suggest two solutions to renew the contract design of commodity mortgage loan as to the allocation of hedging cost.