Optimal Hedging in Futures Markets with Multiple Delivery Specifications.

Abstract

Nearly all futures contracts allow delivery of any of several qualities of the underlyi ng asset. Consequently, the price of the futures contract is associat ed more with the price of the expected cheapest deliverable variety t han with the price of the par-delivery variety. The delivery specific ations introduce a delivery risk for every hedger in the market. The authors derive the optimal hedging strategies in these markets. Their hedging effectiveness is evaluated for wheat futures contracts in Ch icago. Hedging optimally would have significantly reduced the varianc e of the rates of return on hedges, while yielding similar mean retur ns. Copyright 1987 by American Finance Association.