he major upheavals which have buffeted the world economy over the last 15 T years have motivated a considerable amount of research on the question of trade stability and, notably, on commodity price and exchange rate risk. The most important policy issue addressed in this book of literature is how nations can reduce their exposure to these risks. A number of risk-conditioning policy strategies have been discussed such as buffer stocks of key raw materials and foreign exchange pegging (Massell, 1969;Johnson & Sumner, 1976). Some analysts have suggested that futures markets may also provide a viable instrument by which nations can condition their trade-related risk (see, for example, Newbery & Stiglitz, 1981). The purpose of this article is to explore this last option from a theoretical standpoint and then to study a hedging operation by which two low-income countries, South Korea and Egypt, may be able to offset the risk of their net import positions in wheat.
The work presented here continues along the lines first developed by Jacques Rolfo (1980) in his study of cocoa futures hedging for the African cocoa-producing countries and Brazil. Rolfo's study develops an optimal hedging strategy for these countries as a function of the cocoa price and production risks they face. He finds that, when production is risky, it is not optimal for a producer to adopt an "equal but opposite" or 100% hedge. Generally, depending on how risk averse he is, he will hedge substantially less than 100% of his expected production. In his study, 'Giannini Foundation Paper No. 705 (reprint identification only).