Hedging Canadian Feedlot Cattle Revisited

Canadian cattle finishers who wish to hedge their production must use the U.S. futures markets. Prior research has sugggested that Canadian Cattle investors cannot successfully hedge using the Chicago Mercantile Exchange (CME) to manage risk due to variable basis assumed to be caused in part by variable exchange rates. This article reevaluates the use of the CME by Canadian cattle investors feeding heavy feeder steers to slaughter. The study evaluates basis variability, the effect of exchange rates on basis variability and hedging effectiveness. It is shown that Alberta basis is less variable in the latter 1980s than the latter 1970s, Alberta basis is not more variable than the basis at Omaha, variance minimizing hedge ratios are similiar between Alberta and Omaha, and changes in exchange rates have little relationship with changes in Alberta basis. These results suggest that the CME has a role in risk management in Canadian cattle feeding. An historical cattle feeding simulation in Alberta during 1980 to 1989 using heavy feeder steers shows that hedging reduces risk by up to 43%. Exchange rate risk is very low and contributes less than 7% to risk. Basis makes up slightly more than 50% of risk. These results indicate that the CME can be used to manage risk for the cattle investor in Alberta although basis risk is still significant.