Comparison of analytical approaches for estimating hedge ratios for agricultural commodities

Hedging hard red winter wheat: Kansas City versus Chicago

“…Brown (1985) shows, however, that this leads to misspecified hedge ratios. Witt, Schroeder, and Hayenga (1987) defend price-level regressions, stating that the price difference model is preferred only if the order of price differences matches the estimated order of autocorrelation. Most hedgers, though, are not so much concerned with the price level, as with the risk of a price change.…”

Storage profitability and hedge ratio estimation

“…Thus, they claim that "an empirical analysis that examines relationships between levels leads to misspecified hedge ratios and measures of hedging effectiveness" [Hill and Schneeweis (1981, p. 659)]. Witt, Schroeder, and Hayenga (1987) examined optimal hedge ratios through price level regressions, price change regressions, and percentage price change regressions, and found that no one of the techniques was statistically superior to the others. They instead concluded that, from a practical standpoint, the appropriate hedge ratio estimation model should depend on the hedger's objective function, Price level models would be more appropriate when dealing with nonstorable commodities, whereas price change models would be more appropriate for storage models.…”

Risk Management in Agricultural Markets: A Review

“…3 The use of the price level, the price change, or the percentage price change makes a difference in estimates of optimal hedges (e.g., Kahl, 1986;Witt, Schroeder, & Hayenga, 1987).…”