Date of Award
Master of Science
John R. Brooker
Dan McLemore, Charles Farmer
The purpose of this study was to gather information relevant to the marketing decisions with which Tennessee cotton producers are confronted. Specifically, the research focused on the potential of hedging in the futures market as a means of reducing risk associated with cotton price variability. Contents of this study can be divided into three segments: an analysis of the basis for Memphis area cotton, an economic evaluation of alternative cotton marketing strategies, and the derivation of the optimal hedging ratio. The data used for this study consisted of daily Memphis spot prices and daily futures price quotations for cotton with a grade of strict low middling, a staple length of 1 1/16 inches and a micronaire of 3.5 to 4.9. In the first segment of the study, the daily basis was calculated for 1974 through 1985 and analyzed with respect to average levels and variability for the 12 years individually and for the period as a whole. Results showed that the variability of the basis was much lower than the variability of Memphis spot cotton prices. It was also found that there was no detectable tendency of the ending basis to increase or decrease during the 1974 through 1985 period. The evaluation of alternative marketing strategies involved the simulation of 12 marketing strategies using price data for the 1974 through 1985 period. The cash sale at harvest strategy served as a benchmark for the 11 other alternatives, all of which were hedging strategies. Computer programs developed to simulate the hedging strategies accounted for brokerage fees, margin calls, margin withdrawals, and interest costs associated with hedging. Two of the hedging strategies were classified as routine strategies since a hedge was maintained continuously once it was placed. There were five hedging strategies categorized as selective strategies which allowed the hedge to be placed or lifted repeatedly as signalled by moving average indicators. The remaining four strategies dealt with the adjustment of moving average lengths to improve the performance of the hedging strategy. Rules based upon the daily highs and daily lows of the futures contract were used to vary the length of the adjustable moving average. The adjustable moving average concept was effective in increasing the producer's return from hedging. However, the variance of return was generally increased as well. The third part of the study attempted to find the percentage of a producer's cotton that should be hedged in order to minimize the variation of returns. This hedging ratio was estimated first by regressing successive price changes in the spot market on corresponding price changes in the futures market. The slope coefficient of such a regression has been shown to be equivalent to the risk-minimizing hedging ratio in current literature. A risk-minimizing hedging ratio was also found for each hedging strategy simulated. Strategy-specific hedging ratios were estimated by regressing the returns from the spot market position on the returns from the futures market position. In other words, the actual returns from spot and futures positions were used rather than spot and futures price changes. The size of the risk-minimizing hedging ratios derived from price changes over various time intervals were affected by the length of interval used. None of the strategy-specific optimal hedging ratios were significantly different from one at the 95 percent level of significance.
Davis, Carleton S., "An economic evaluation of alternative marketing strategies for Tennessee cotton producers. " Master's Thesis, University of Tennessee, 1986.