The volatility of coffee prices exposes coffee producers to price risk. Price risk is one of many risks faced by commodity producers in developing countries. Coffee is widely traded in the international commodity derivative markets. This offers scope for coffee producers to manage their price risk by hedging on these markets. The hedging mechanism recommended is based on the use of coffee futures and options. The mechanism involves costs, so the benefits of hedging need to be evaluated in order to assess its usefulness for producers. It emerges that the main benefit lies in producers being able to allocate resources more efficiently in the production of coffee. An analysis of theoretical and field evidence shows that this benefit can potentially be quite high, especially for risk-averse producers. This underlines the need to provide producers with access to suitable price-risk hedging mechanisms.

It is commonly felt that the liberalisation of commodity markets has increased the exposure of commodity producers to price volatility. Using a generalized autoregressive conditional heteroskedasticity framework, we make a distinction between the predictable and unpredictable components of volatility, the latter exposing producers to price risk. By using empirical estimates of the coefficient of relative risk aversion drawn from the literature, we show that the welfare gain from eliminating this price risk for Indian coffee producers is on average 4.8 percent of their revenue from coffee sales, which for a poor producer may be more than a month's income. This underlines the need for providing producers access to suitable price-risk management or hedging mechanisms.JEL Classifications: D13, D81, Q13, Q12