The Theory of Hedging and Speculation in Commodity Futures

  • Leland L. Johnson


Although significant contributions have appeared in the literature in recent years, the present day theory of hedging and speculation appears to account inadequately for certain market practices. In particular, the motivation of the trader who undertakes hedging activities, the role that hedging plays in his over-all market operations, and the distinction between a trader who hedges and one who speculates have given rise to difficulties in the literature. My purposes here are (1) to outline briefly the purposes and mechanics of a commodity futures market, (2) to discuss and appraise the theory of hedging and speculation as it exists today, (3) to present a reformulated concept of hedging, and (4) to construct a model that may both assist in clarifying the concepts of hedging and speculation and contribute to a better understanding of certain market phenomena.


Price Change Future Market Future Price Future Contract Spot Price 
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  1. 3.
    See, for example, P. A. Samuelson, Economics, An Introductory Analysis, 4th edition, New York, 1958, p. 425.Google Scholar
  2. 4.
    R. G. Hawtrey, ‘Mr. Kaldor on the Forward Market,’ Review of Economic Studies, vol. VII, 1940, p. 203.Google Scholar
  3. 5.
    A Treatise on Money London, 1930, vol. II, chap. XXIX. This theory has been elaborated by J. R. Hicks in Value and Capital 2nd ed., Oxford, 1946, pp. 137–9.Google Scholar
  4. and has been extensively treated by N. Kaldor in ‘Speculation and Income Stability,’ Review of Economic Studies vol. VII, 1939, pp. 1–27.CrossRefGoogle Scholar
  5. An interesting recent analysis of the financial results of speculation in commodity futures is contained in H. S. Houthakker, ‘Can Speculators Forecast Prices?’ Review of Economics and Statistics vol. XXXIX, 1957, pp. 141–51.Google Scholar
  6. 8.
    For a detailed discussion of this point, see L. L. Johnson, ‘Price Instability, Hedging and Trade Volume in the Coffee Market,’ Journal of Political Economy, vol. XLV, 1957, pp. 319–21.Google Scholar
  7. 9.
    L. G. Telser in ‘Safety First and Hedging,’ Review of Economic Studies vol. XXIII, 1955–56, pp. 1–16, demonstrates the rationality of holding hedged and unhedged positions simultaneously but operates under the highly restrictive assumption that the trader maximizes expected income under the constraint that the probability of the occurrence of a given ‘disaster’ level of income not exceed a given value.CrossRefGoogle Scholar
  8. M. J. Brennan in ‘Supply of Storage,’ American Economic Review vol. XLVIII, 1958, pp. 69–70, mentions briefly the simultaneous holding of both hedged and unhedged stocks on the basis of risk above a ‘critical’ level being transferred to speculators via hedging.Google Scholar

Copyright information

© Palgrave Macmillan, a division of Macmillan Publishers Limited 1976

Authors and Affiliations

  • Leland L. Johnson

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