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Master of Agribusiness

Cross-Hedging Feed Ingredients

Angie Pierce, Emporia, Kansas, defended her thesis, “Cross-Hedging Feed Ingredients,” Monday, August 1, 2005. Pierce is a Commodity Broker for Flint Hills Commodities in Emporia, Kansas.

There are many alternative feed ingredients that are grains and by-products of grain processing that have no direct futures markets with which to hedge.  Pierce examined the relationship between the price of nine different cash feed ingredients and existing agricultural futures markets on the Chicago Board of Trade and Kansas City Board of Trade through regression analysis.  The regression equations estimate the basis and hedge ratios as well as give the correlation coefficient between the cash feed ingredient and the futures market.  Cross-hedge effectiveness studies are conducted to see how effective cross-hedging is for each feed ingredient. The goal of her paper was to determine whether cross-hedging is a viable strategy for price risk reduction for the feed ingredients of: corn gluten feed, corn gluten meal, cottonseed meal, dehydrated alfalfa pellets, distillers dried grains, milo, rice millfeed, wheat middlings and whole cottonseed.

She found cross-hedging was a good option for some feed ingredients, but not all. “Through regression analysis, it was determined that cross-hedging via corn, soybean, wheat or soybean meal futures is effective at reducing price risk for very few feed ingredients. The feed ingredients where cross-hedging is feasible are milo, corn gluten meal, cottonseed meal and to a lesser extent distillers dried grains,” Pierce said.

Dr. Ted Schroeder, Pierce’s thesis advisor, believes Pierce’s findings are important for anyone who may be pursuing cross-hedging.

“Price risk management of many feed ingredients such as distiller’s dried grains or corn gluten meal is challenging because active futures markets do not exist to use as a direct hedging instrument.  One alternative is to consider using available futures markets such as corn or soybean meal futures to cross hedge the commodity of interest.  Success of a cross hedge protecting against adverse price risk depends critically upon the strength of the price relationship between the cash market commodity price and the commodity futures price of interest to us as a cross-hedging instrument,” Schroeder said. “Ms. Pierce’s work estimates the nature of cross-hedging opportunities for a variety of feed ingredients, assesses the viability of the cross hedges, and shows the magnitude of risk that can be offset by the particular cross hedge.  This information is essential for anyone considering such cross hedging activity.”