Cross-hedging performance of wholesale beef in live cattle futures contracts revisited

Abstract

Risk management decision makers face significant price risk when purchasing or selling wholesale beef. Previous research has identified cross-hedging wholesale beef in Live Cattle futures as a plausible means of reducing this risk. Changes in the way beef is marketed have led to poor performance of cross-hedging programs. Unlike earlier research, more recent studies have shown that Live Cattle futures are a poor venue for effective cross-hedging. This study replicates previous research to evaluate the current state of traditional cross-hedging performance. Focus then shifts to improving cross-hedging methods. Hedge ratios derived from a traditional cross-hedging methodology exhibit a great deal of sensitivity to season, estimation technique, and quality grade. Basis risk is abundant for this type of cross-hedging. To reduce the basis risk inherent with cross-hedging wholesale beef, bundling is proposed. This involves combining two or more cuts together in a single unit to be cross-hedged. Firms merchandising meat from a whole carcass would be able to provide a valuable risk management service if the basis risk faced when hedging a bundled product is less than the basis risk faced when cross-hedging the corresponding products independently. This research found that bundling has neither a positive or negative effect on basis risk. Therefore bundling is a plausible practice, but will not offer reduced basis risk to decision makers.