Stabilizing export revenue through futures markets: an application to cocoa exporting countries
Atapattu, Nihal K.
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Many developing countries that rely heavily on primary commodity exports to provide a major portion of their exchange revenues confront large variability in their incomes. This has been a factor of major concern to the developing countries as revenue instability is considered to deter development as well as affect the welfare of those engaged in production of such commodities. Producing countries have adopted several programs and policies that attempt to lessen the price and revenue instabilities, or to raise export receipts. These attempts based on various commodity agreements have met with limited success. More attention has been paid to the alternative market solutions to this problem as international action even among producers has proven ineffective. Futures market is an obvious choice since well organized futures markets exist for most of the primary commodities. The present study investigated the potential of futures markets as a means of obtaining lower variance in revenue using the data from cocoa markets in London and New York. Data for four representative cocoa producers were analysed to develop strategies that reduce the variance in revenue. Two hedging strategies based on optimal hedge ratio concept and three selective strategies were tested for their ability to reduce risk and also to maintain the revenue trade-offs at a lower level. The analyses were carried out using two sample periods each 29 and 22 years long and tested in a 4 year data base outside the sample. The results confirmed that the producers facing both price and quantity risks in their production should only hedge a portion of their output. Adoption of a variance minimizing or utility maximizing hedges at a higher levels of risk aversion parameter as well as some selective strategies for hedging were found to give lower variance in revenue. There was always some trade-off associated with adopting these strategies. Selective strategies obtained a reduction in revenue with less trade-offs compared to optimizing strategies but were limited by the requirements of large cash outlays to meet the margin payments. For countries depending heavily on the revenue from cocoa hedges based on variance minimizing or utility maximizing strategies would be preferred over selective strategies. The ability to make good crop forecasts would greatly improve the success of hedging.
- Masters Theses