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Optimizing Hedging Effectiveness of Indian Agricultural Commodity Futures: A Simulation Approach

Optimizing Hedging Effectiveness of Indian Agricultural Commodity Futures: A Simulation Approach Indian agricultural commodity futures have seen declining volumes over the last ten years. Several studies in the literature have suggested that this may be due to their hedging effectiveness being, in general, low. To prevent manipulation, location options are embedded into such commodity futures allow for the short position holder at expiration to deliver several non-par assets in addition to the par asset. Choices of delivery specifications pertaining to the location option can impact hedging effectiveness of the futures contract. We use a Monte Carlo approach to guide the choice of these delivery specifications including the number of deliverable assets, their inter-se correlations, discounts incurred for delivery of non-par assets and contract life, with the goal of optimizing hedging effectiveness of futures. We also corroborate the results of simulations with empirical evidence. The simulations, while confirming some of the empirical results in the literature also suggest several additional insights for the optimal selection of contract delivery specifications and provide contract designers with comprehensive guidelines for making choices of contract delivery specifications. These results also confirm the necessity for regulators and exchanges to focus on and constantly optimize delivery specifications of such futures contract to make them more useful for hedgers by improving their hedging effectiveness. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Asia-Pacific Financial Markets Springer Journals

Optimizing Hedging Effectiveness of Indian Agricultural Commodity Futures: A Simulation Approach

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References (30)

Publisher
Springer Journals
Copyright
Copyright © The Author(s), under exclusive licence to Springer Japan KK, part of Springer Nature 2021
ISSN
1387-2834
eISSN
1573-6946
DOI
10.1007/s10690-021-09355-3
Publisher site
See Article on Publisher Site

Abstract

Indian agricultural commodity futures have seen declining volumes over the last ten years. Several studies in the literature have suggested that this may be due to their hedging effectiveness being, in general, low. To prevent manipulation, location options are embedded into such commodity futures allow for the short position holder at expiration to deliver several non-par assets in addition to the par asset. Choices of delivery specifications pertaining to the location option can impact hedging effectiveness of the futures contract. We use a Monte Carlo approach to guide the choice of these delivery specifications including the number of deliverable assets, their inter-se correlations, discounts incurred for delivery of non-par assets and contract life, with the goal of optimizing hedging effectiveness of futures. We also corroborate the results of simulations with empirical evidence. The simulations, while confirming some of the empirical results in the literature also suggest several additional insights for the optimal selection of contract delivery specifications and provide contract designers with comprehensive guidelines for making choices of contract delivery specifications. These results also confirm the necessity for regulators and exchanges to focus on and constantly optimize delivery specifications of such futures contract to make them more useful for hedgers by improving their hedging effectiveness.

Journal

Asia-Pacific Financial Markets – Springer Journals

Published: Mar 1, 2023

Keywords: Hedging effectiveness; Location options; Agricultural commodity futures; Monte carlo simulation; C63; G18; G23; Q02

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