Heterogeneity of Cash Markets at Physical Delivery Points and the Hedging Effectiveness of Agricultural Commodity Futures in India – Lessons for Contract Optimization.
Abstract
Agricultural commodity futures in India are settled by physical delivery and the seller can choose the location of delivery from a list described in the contract specifications. Cash markets at these locations represent the deliverable basket for the futures contract and are the underlying assets for the delivery options granted to the seller by virtue of contract design. These cash markets are generally heterogenous. This paper studies the impact of heterogeneity of the underlying cash markets in different locations on the hedging effectiveness of the associated futures contract. The hedging effectiveness of cottonseed oilcake and soybean futures is regressed against several variables that represent heterogeneity of the underlying cash markets using ridge regression. We find that in general, the greater the heterogeneity, the poorer the hedging effectiveness of the contract. This paper is unique in that it provides a framework for guidance for contract designers at exchanges and regulators who will find this research useful in optimizing delivery specifications for agricultural futures contracts. This is especially important given the declining volumes in Indian agricultural commodity futures.
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Copyright (c) 2020 Sanjay Mansabdar, Hussain C Yaganti
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