CRIEFF Discussion Paper Number 0210
The Derived Demand with Hedging Cost Uncertainty in the Futures Markets:
Note and Extensions
Moavia Algalith
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Abstract
Paroush and Wolf (1992) investigated a perfectly competitive firm which faces
input price uncertainty in one input of its two-input production function.
The main purpose of their study was to determine the impact of the technological
relationship on the derived demand when the input is hedged in a forward
or futures market. They found that the partial cross derivatives of the production
function and the market structure of the futures price (upward or downward
bias) affect the derived demand. This note provides two extensions. First,
it generalises Paroush and Wolf's theorem by using general utility function
(Theorem 1). Second, it adds a new theorem (Theorem 2) that shows the impact
of adding basis risk on the optimal hedging. This theorem is equally important
since hedging is a decision variable. Below is a description of Paroush and
Wolf's model.
Key Words
Cost uncertainty, forward market, futures market, hedging, input price
uncertainty
JEL Classifications
D8
Moavia Algalith
University of St Andrews
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