Optimal hedging in a processing environment: a case of ethanol production Online publication date: Mon, 17-Jan-2022
by William Wilson; Kristopher Skadberg; Iddrisu Awudu; Bruce Dahl; Mariama Yakubu
International Journal of Revenue Management (IJRM), Vol. 12, No. 3/4, 2021
Abstract: Hedging is an important strategy to reduce risk for most processing firms. In this paper, we determine optimal hedging strategies for an ethanol processing firm with input (corn), and outputs [ethanol, distillers dried grain soluble (DDGs), and corn oil]. Strategic decisions regarding alternative underlying cash and futures positions, in addition to hedge ratios, quantity of ethanol and corn to buy or sell, and co-products are considered in this work. We develop portfolio optimisation models with different risk (hedging) specifications that incorporate copula distributions to evaluate among alternative hedging strategies. The results indicate lower standard deviations for traditional hedges with higher returns using ethanol futures (specifically ethanol platt futures). Meanwhile, we find that hedging ethanol using a short position has a higher standard deviation and a lower value-at-risk (VaR) than an unhedged ethanol position.
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