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Production, storage, and futures hedging under uncertainty

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  • Nijsse, Erwin

    (Groningen University)

Abstract

This paper provides an integrative survey of literature on commodity futures markets, on storage and production decisions, and on joint spot and futures price formation under uncertainty. The paper focuses on the risk reallocation role of futures markets. Basic models of futures trading by a competitive, risk-averse firm are enhanced with production and storage decisions in a static and dynamic setting. Through inventories and futures hedging both risk premia and an endogenous convenience yield play a role in the firm’s optimisation process. We thus provide a microeconomic foundation for the complementary relationship between the theory of normal backwardation and the theory of supply of storage. Because most futures users operate in an incomplete market setting, special attention is paid to the interaction of production, storage, and hedging determinants, the existence of risk premia and opportunities for diversification of portfolios.

Suggested Citation

  • Nijsse, Erwin, 2001. "Production, storage, and futures hedging under uncertainty," Research Report 01E10, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
    • Handle: RePEc:gro:rugsom:01e10
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    File URL: http://irs.ub.rug.nl/ppn/217986404
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    Cited by:

    1. Wong, Kit Pong, 2006. "The effects of abandonment options on operating leverage and forward hedging," International Review of Economics & Finance, Elsevier, vol. 15(1), pages 72-86.

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