The Failure of Multi-Year Hedge-to-Arrive Contracts

Abstract

<p>In the late 1980s, grain elevators in Ohio developed the hedge-to-arrive contract (HTA) to induce farmers to use their grain handling facilities and/or merchandising services. Farmers wanted to use HTAs to lock-in abnormally attractive price levels for more years of expected production. Supposedly, the multiple-year HTA would lock-in those attractive prices without farmer margin calls (money required by commodity brokers as security against default) if futures prices rose further. A National Grain and Feed Association survey in early 1996 found that 45 percent of responding elevators offered single or multi-year HTAs, accounting for 6 percent of their grain volume. Many multi-year HTAs proved to be an economic disaster in 1996 when corn prices skyrocketed to unprecedented levels. The false premise underlying the contract design which we discuss in this paper became exposed in dramatic fashion. How did this disaster happen? How might it be prevented in the future?</p>