Managing colombian farmers price risk exposure with electrical derivatives market

Abstract

Food security is among the most pressing global concerns. It is principally threatened by the combination of rural migration and the pressure of climate change. In order to mitigate these effects, the need to promote stable conditions for small producers -who generate 80% of the world's food- has arose. In search to improve market conditions, this study aims to evaluate the feasibility of cross-hedging between electrical derivatives market and spot agricultural products in Colombia. This hypothesis is proposed, as Colombia depends upon hydro-electricity, an electricity source which is heavily influenced by climatic conditions, particularly the “El Niño” southern oscillation (ENSO). The prices of agricultural products are thus volatile, and subject to this phenomenon. ENSO is presumed to be an important link between these two markets. To contrast the hypothesis, the most commonly- methods in cross-hedging literature were employed to estimate hedge ratios: OLS, Error Correction Models, and GARCH estimations. This last estimation was found to be the one with the best performance for hedge ratio estimation. Despite this, of 93 products analyzed, statistically significant relationships were found for only nine. Besides, it was found that cross-hedging contributes to a risk reduction of not more than 32%.

Keywords

• Agriculture cross-hedging
• Agriculture risk management
• Sustainable risk management
• Price risk exposure
• Food security
• Agricultural economics