Price level risk management in the presence of commodity options: income distribution, optimal market positions, and institutional value

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1988
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Hanson, Steven
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George W. Ladd
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Economics

The Department of Economic Science was founded in 1898 to teach economic theory as a truth of industrial life, and was very much concerned with applying economics to business and industry, particularly agriculture. Between 1910 and 1967 it showed the growing influence of other social studies, such as sociology, history, and political science. Today it encompasses the majors of Agricultural Business (preparing for agricultural finance and management), Business Economics, and Economics (for advanced studies in business or economics or for careers in financing, management, insurance, etc).

History
The Department of Economic Science was founded in 1898 under the Division of Industrial Science (later College of Liberal Arts and Sciences); it became co-directed by the Division of Agriculture in 1919. In 1910 it became the Department of Economics and Political Science. In 1913 it became the Department of Applied Economics and Social Science; in 1924 it became the Department of Economics, History, and Sociology; in 1931 it became the Department of Economics and Sociology. In 1967 it became the Department of Economics, and in 2007 it became co-directed by the Colleges of Agriculture and Life Sciences, Liberal Arts and Sciences, and Business.

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1898–present

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  • Department of Economic Science (1898–1910)
  • Department of Economics and Political Science (1910-1913)
  • Department of Applied Economics and Social Science (1913–1924)
  • Department of Economics, History and Sociology (1924–1931)
  • Department of Economics and Sociology (1931–1967)

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Abstract

Optimal risk management behavior is studied for decision makers who wish to manage price level risk with commodity futures and options contracts. The income distribution that results when both futures and put options are held in a risk management portfolio is derived for the case of a known end-of-period output level. The resulting income distribution is the sum of two truncated normal distributions and violates the sufficient condition that causes the linear mean-variance model to produce results which are consistent with expected utility maximization. Numerical integration and numerical optimization methods are developed to solve the expected utility maximization problem. The optimal market positions are found for a predetermined set of market characteristics in both the mean-variance and expected utility maximization problem. The optimal market positions are found for a predetermined set of market characteristics in both the mean-variance and expected utility frameworks for the case of a certain end-of-period output level;The relationship between the expected utility market positions and the relevant market factors are estimated using a polynomial function. Localized comparative static results are generated using the numerical solution methods. The results show that the decision maker will hedge his/her end-of-period output in the futures market using the traditional one-to-one hedge and then speculate in both markets if either market is believed to be biased. The value of using the expected utility solutions instead of the solutions produced by the mean-variance or polynomial approximation models is shown to be quite small for the levels of market factors considered in the study. If both the futures and put options markets are unbiased, there is no value in adding a put options market when a futures market currently exists. If a bias exists in either market, there is value in adding a put options market when a futures market currently exists, although the value is relatively small.

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Fri Jan 01 00:00:00 UTC 1988