JOURNAL OF ECONOMIC THEORY 53, 304327 ( 1991) Seasonal Patterns of Futures Hedging and the Resolution of Output Uncertainty*

Optimal futures hedging is examined in a two-good model with stochastic output and sequential information arrival. A producer’s optimal hedge depends on demand elasticity, sensitivity of his output to weather. his correlation with aggregate output, and how rapidly his output uncertainty is resolved relative to other producers during different seasonal periods. Because regional output uncertainties are resolved at different times, the optimal futures position of a grower will commonly reverse in direction during the crop year. A producer with non-stochastic output who faces price risk arising from demand shocks may remain unhedged or even maintain a long position, Journa / qf Economic Liferature Classification Numbers: 022. 521. 714.:( ’ 1991 Academic Press. Inc. An issue that is central to the analysis of commodity futures markets is the determination of optimal hedging positions of producers. To the extent that growers or handlers of a commodity are risk-averse, they have an incentive to hedge on the associated futures market to offset the revenue variability of their businesses. If other means of risk reduction such as equity issuance are costly, owing either to transaction costs or to the problems of moral hazard and adverse selection, futures hedging becomes an important means of controlling risk. Most research on optimal hedging has employed models that are “partial equilibrium, ” in the sense that the consumption choice between the commodity underlying the futures contract and other commodities is not modeled. Instead, decisionmakers are assumed to derive utility from generalized wealth, which is equivalent to assuming only a single consump-* I thank a referee of this journal, Avi Kamara, Warren Bailey and Francis LongstaR for helpful comments