Impacts of Hedging with Futures on Optimal Production Levels

Abstract

Decisions about the kind of risk management not only influence the optimal hedging volume, but also affect the optimal production level. We compare hedging advices in two different model environments. Optimal production levels (and optimal hedging volumes) are determined in models with and without futures markets in a conventional modeling approach and in a rational expectations equilibrium (REE). Results differ substantially. Hedging on the futures market is always advantageous and leads to an increased output in the conventional setting, if short hedging (normal hedge or reversed hedge) is optimal. In our REE-model, in case of non-zero output level, only normal hedge is compatible with the assumption of risk-averse market participants. Nevertheless, an active risk management is not always advantageous. If the number of producers exceeds the number of speculators, producers should only take positions on the futures market, when information about a decreasing spot market demand (which has to lie between certain bounds) prevails in the market.