THE EFFECTIVENESS OF SIMPLE CROSS HEDGES FOR SORGHUM AND SUNFLOWER SEEDS

Abstract

One key purpose of futures markets is allowing firms to trade contracts which will change in value in the opposite direction of the value of the product which the firm produces. This process, known as �hedging�, allows firms to decrease their risk of large losses. Cross-hedging occurs when a firm tries to hedge a product with a futures contract which is tied to a different product. In this paper, I examine the viability of cross hedging sunflower seeds with soybean meal and soybean oil, as well as sorghum with corn. The suitability of these commodities for cross-hedging has not been thoroughly studied recently, despite their substantial role in the U.S. and world economy. I used historical data to determine how closely changes in the given futures prices are linked to changes in the spot prices of sorghum and sunflower seeds. Using two different hedge intervals, I found that corn provided an effective hedge against sorghum, while soybean meal and soybean oil failed to adequately hedge against sunflower seeds. I also found that longer hedge intervals improved hedge effectiveness. These results inform hedgers on the quality of the hedging strategies, and shed insight into sorghum and sunflower seed markets.