Analysis of Hedge Ratios and Hedging Effectiveness of Atlantic Salmon Futures

Abstract

Over the years salmon farming has become one of the most important industries in Norway. Nevertheless, salmon is known to be a price-volatile commodity. In June 2006, an Atlantic salmon futures contract was listed on Fish Pool ASA, which is a regulated market place for seafood derivatives. The purpose was to let participants minimize possible revenue losses associated with adverse salmon spot price changes by taking positions in the salmon futures market. One crucial factor for a futures contract to succeed is the risk-reduction ability. The purpose of this thesis was to investigate whether the Atlantic salmon future contract provides a good hedge. In order to analyze this I have evaluated different hedging horizons of the front month contract. The optimal futures position (hedge ratio) is found by minimizing the variance of the spot-futures portfolio. I have estimated constant optimal hedge ratios by simple regression, and time varying ratios are calculated from the EWMA (exponentially weighted moving average) estimation method. From these estimations the hedging effectiveness is calculated. The results show that it is favorable to hold the front month contract until maturity. From this hedgers can achieve a hedge effectiveness of approximately 39\%. Another important finding is that the weekly spot-future return correlation is extremely low. For this reason one-week hedges provide almost no risk reduction. The time varying estimations reveal that the hedge effectiveness remained stable during the beginning of the period, but has decreased the past 2-3 years. This is not promising for the future existence of this contract. Even though the salmon futures contract provides a fairly good hedge, the hedge effectiveness is still much lower than for many other agricultural commodity futures. This may be explained by the spot-forward price relationship, the settlement procedure, the dominance of hedgers and the low liquidity.