Hedging Efficiency of Commodity Futures Markets in India

The IUP Journal of Financial Risk Management, Vol. IX, No. 2, pp. 40-58, June 2012

Posted: 3 Nov 2012

Date Written: October 31, 2012

Abstract

The present study investigates the hedging effectiveness of commodity futures contracts for spices and base metals by employing cointegration and error correction methodology with different maturity time horizons varying from one month to three months, i.e., maturity month, nearby month and far month. The optimal hedge ratios are calculated from Ordinary Least Squares (OLS) regression and Error Correction Model (ECM). It is found that the futures market dominates in price discovery in nearby month contracts. In far month contracts, there is no long-term relationship between spot and futures prices for turmeric and cardamom. In case of base metals, futures market leads spot market for all the three contracts. This study supports that futures price representing the collective market opinion is considered as reference price for spot market players like traders, farmers and other stakeholders in commodity trading domain. Hedging effectiveness is also measured at various maturity periods. The results suggested that only 40% of contracts are suitable for hedging. It is generally found that there is no significant difference in hedging performance between far month and nearby month maturity periods for spices, while in the case of base metals slight variation is seen in hedging performance among different maturity periods. Further, there is not much difference in the estimates of hedging effectiveness obtained from OLS method and ECM. It is found that for far and nearby maturity periods hedging is more effective, which has some important implications for hedging strategy. These findings are helpful to risk managers, farmers, stakeholders and policy makers.

Suggested Citation

Yaganti, C. Hussain and Kamaiah, B., Hedging Efficiency of Commodity Futures Markets in India (October 31, 2012). The IUP Journal of Financial Risk Management, Vol. IX, No. 2, pp. 40-58, June 2012, Available at SSRN: https://ssrn.com/abstract=2169227

C. Hussain Yaganti (Contact Author)

BITS-Pilani, Hyderabad Campus ( email )

Hyderabad Campus
Hyderabad
India

B. Kamaiah

Independent ( email )

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