A Bayesian Approach to Optimal Cross-Hedging of Cottonseed Products Using Soybean Complex Futures

Abstract

Cottonseed crushers face substantial risk in terms of input and output price variability and they are limited in their planning by the lack of a viable futures contract for cottonseed or cottonseed products. This study examines the feasibility of cross-hedging cottonseed products using the soybean complex futures. Different cross-hedging strategies are evaluated for eight time horizons relative to the expected profit and utility of the crusher. A Bayesian approach is employed to estimate both model parameters and optimal hedge ratios, allowing consistency with expected utility maximization in the presence of estimation risk. The results reveal that both whole cottonseed and cottonseed products can be successfully cross-hedged using soybean complex futures. The profitability of cross-hedging cottonseed products depends on the size of the contract, the optimal choice of strategy, the time of hedge placement, and the hedging horizon.

Keywords

• bayesian decision science
• cottonseed
• cross-hedging
• risk management