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Explaining Virginia slaughter cattle basis :an empirical examination of the elements affecting cash price in local Virginia markets
Botkin, Clayton Jay
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This research quantifies specific cash price premiums and discounts associated with various characteristics of slaughter cattle in Virginia. Econometric models of Virginia slaughter cattle basis were developed for each practical combination of sex and market by differentials in weight, grade, breed, lot size, order of sale of a particular lot, number of cattle in a particular sale, and a seasonal indicator based on the Chicago Mercantile Exchange (CME) live cattle futures contract month. Explanatory models were found to account for 41 to 64 percent of the variation in slaughter cattle basis for steers and 35 to 47 percent of the variation in slaughter cattle basis for heifers. Results explain over 30 percent more of basis variation than previous research. These basis estimates reduce basis error and hedging risk and potentially offer Virginia cattlemen the means to initiate effective slaughter cattle hedging programs. Furthermore, the implementation of a forward pricing agency which uses estimated basis values may provide alternatives to facing basis risk when selling slaughter cattle in Virginia. An analysis of basis risk provides some indication of the magnitude of possible exposure facing the average Virginia cattleman when making hedging decisions based on estimation procedures as defined herein. The formation of a forward pricing agency should be contingent upon further analyses of basis risk as outlined in this research. Investigation of basis estimate residuals concluded that more variability is present as time to contract maturity increases. This information should prove valuable for those involved in trading options on live cattle futures as options expire one month prior to their respective futures contracts.
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