| In many studies the assumption is made that traders only encounter one type of price risk. In reality, however, traders are exposed to multiple price risks, and often have several relevant derivative instruments available with which to hedge price uncertainty. When hedging several types of related price risk, with several futures contracts, the risk-minimizing and/or the optimal hedged position should not only take into account the futures contracts' covariability with its cash position, but also the covariability with other related futures and cash positions.;In this study, commodity, foreign exchange, and freight futures contracts are analyzed for their effectiveness in reducing price uncertainty for international grain traders. A theoretical model is developed for both a representative exporter and importer to depict a realistic trading problem encountered by an international grain trading corporation exposed to more than one type of price risk. The traditional method of estimating hedge ratios by Ordinary Least Squares (OLS) is compared to both the Seemingly Unrelated Regression (SUR) approach and the multivariate GARCH methodology, which takes into account time-varying variances and covariances between the cash and futures markets. Explicit modeling of the time-variation in futures hedge ratios via the multivariate GARCH methodology, using all derivatives and taking into account dependencies between markets, results in a significant reduction in price risk for grain traders.;The results also confirm that the unique, but underutilized, freight futures market is a potentially useful mechanism for reducing price uncertainty for international grain traders. Moreover, the use of freight futures significantly outperforms cross-hedges with fuel oil futures in terms of risk minimization. This is of interest because this contract has been proposed as an alternative hedging mechanism for reducing freight price uncertainty. The research undertaken in this study provides valuable information about reducing price uncertainty for international grain traders and gives a better understanding of the linkages between closely related markets. |
