Alternative techniques for cross-hedging wholesale beef prices

✍ Scribed by Stephen E. Miller; Dawson B. Luke

• Publisher: John Wiley and Sons
• Year: 1982
• Tongue: English
• Weight: 478 KB
• Volume: 2
• Category: Article
• ISSN: 0270-7314
• DOI: 10.1002/fut.3990020203

✦ Synopsis

I

dressed-meat prices. Restaurants or fast food chains face the dilemma of when to change the prices of their products in response to changes in wholesale meat prices. Poor timing of price changes could result in a loss of profit. Institutions in the public sector such as hospitals and penal systems which operate on fixed annual budgets face a somewhat different problem. An unforeseen increase in the cost of a major item, such as dressed meat, could cause a problem if the cost exceeded the fixed budget. Both private and public food service establishments should welcome a way to reduce the risk of price fluctuations.

A possible risk management tool for food service institutions facing uncertain meat prices is the hedging of meat purchases on futures markets. A major problem in the hedging of meat products is that direct hedging is possible only for pork bellies and imported lean beef; futures markets for other meats presently do not exist. Institutions desiring to hedge meats other than pork bellies and imported lean beef would have to cross-hedge. By definition, cross-hedging is the hedging of a cash position in one commodity by using the futures market for a different but related commodity. Besides being used to forward price commodities for which futures markets do not exist, cross-hedging is also used when existing futures markets do not provide sufficient liquidity for direct hedging, and when the basis from direct hedging is unsatisfactory (Hieronymus, 1971, p. 233). There is only limited evidence regarding the effectiveness of existing futures markets as cross-hedging media (Hieronymus, 1971;Miller, 1980; Ward and Schmikat, 1979).

The purpose of this article is to investigate whether cross-hedging with live cattle futures offers food service institutions the opportunity to reduce their ex-