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A Model of Hedging and Futures Price Bias


The model examines the underlying spot market determinants of hedging and risk premia. The analysis takes into account spot market clearing, quantity and price variability, stock market portfolio opportunities, diverse output distributions of producers, demand and supply shocks, and supply response to demand shifts. Hedging positions are related to the correlation and relative sensitivity of producers' outputs to the environment. Futures price bias arises from a variety of sources. Demand price elasticity affects the risk premium when output is variable; supply price elasticity when demand is variable. Income elasticity raises the premium, and fixed costs of futures market participation raise the absolute magnitude of bias.

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