Futures market hedging efficiency in a new futures exchange: Effects of trade partner diversification

• Author: Atle Oglend,Hans‐Martin Straume
• Published date: 01 April 2020
• DOI: http://doi.org/10.1002/fut.22088
• Date: 01 April 2020

J Futures Markets. 2020;40:617–631. wileyonlinelibrary.com/journal/fut © 2019 Wiley Periodicals, Inc.

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617

Received: 11 February 2019

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Accepted: 8 December 2019

DOI: 10.1002/fut.22088

RESEARCH ARTICLE

Futures market hedging efficiency in a new futures

exchange: Effects of trade partner diversification

Atle Oglend

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Hans‐Martin Straume

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1

Department of Industrial Economics,

University of Stavanger, Stavanger,

Norway

2

Department of Economics, BI Norwegian

Business School, Bergen, Norway

Correspondence

Atle Oglend, Department of Industrial

Economics, University of Stavanger,

4036 Stavanger, Norway.

Email: atle.oglend@uis.no

Funding information

Norges Forskningsråd,

Grant/Award Number: 233836

Abstract

This paper uses transaction data to examine hedging efficiency in a new futures

exchange; the Fish Pool salmon futures exchange in Norway. The paper utilizes

data on firm‐level exporter/importer transaction prices to quantify firm‐level

futures hedging efficiency. This allows us to address heterogeneity in hedging

efficiency and basis risk at the firm level. The main result of this paper shows

that larger firms with greater trade partner diversification have lower basis risk.

Such firms align their internal transaction price closer to the common spot price

in the market, which encourages greater futures market participation. Results

are discussed in light of recent declines in participation in the salmon futures

exchange.

KEYWORDS

diversification, futures, hedging efficiency, trade

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INTRODUCTION

Well‐designed futures contracts allow efficient hedging of price risk. This has been demonstrated for several futures

contracts and exchanges (see for instance Lien, Lee, & Sheu, 2018, for a recent overview). However, the success of any

particular contract or exchange is not certain. Bernardo and Welch (2004) state that of the 250 contracts approved by

the Commodity Futures Trading Commission from 1975 to the early 1990s, only about one‐third of contracts succeeded.

In a detailed case study of the failure of the Minneapolis Grain Exchange black tiger and white shrimp future contracts,

Martinez‐Garmendia and Anderson (1999) point to weak hedging efficiency due to lack of commodity homogeneity

relative to contract specifications. While the literature has provided many important characteristics of successful

contracts and exchanges (Brorsen et al., 2001; Gray, 1966; Pennings & Meulenberg, 1997a, 1997b; Pennings et al., 2003),

there is relatively little empirical analysis of firm level determinants of hedging efficiency. To investigate hedging

efficiency, much research relies on analyzing price aggregates such as spot price indices (see Lien et al., 2018 and

references therein). While aggregates can inform on the hedging efficiency faced by some representative hedger, they

cannot inform on how differences across firms in the markets translate to differences in hedging efficiency. This

omission is important. It is fundamentally the decision of individual agents whether to participate in some futures

market. A better understanding of how firm characteristics affects hedging efficiency can provide a more solid

foundation to evaluate the successes and failures of futures markets.

In this paper, we utilize a unique data set of firm‐level exporter/importer transaction prices for Norwegian salmon to

investigate futures hedging efficiency at the firm level. The data covers the majority of first‐hand exporter/importer

transactions of farmed fresh salmon from Norway over the lifetime of the salmon futures exchange. It covers almost all

individual first‐hand transactions that would be relevant to hedge using the futures. This allows a unique disaggregated

analysis of determinants of hedging efficiency during the lifetime of a futures exchange.