The IUP Journal of Applied Economics
Impact of Embedded Location Options on Hedging Effectiveness of Agricultural Commodity Futures: Evidence from Chana Futures in India
Article Details
| Pub. Date | : Oct, 2023 |
|---|---|
| Product Name | : The IUP Journal of Applied Economics |
| Product Type | : Article |
| Product Code | : IJAE031023 |
| Author Name | : Sanjay Mansabdar and C Hussain Yaganti |
| Availability | : YES |
| Subject/Domain | : Economics |
| Download Format | : PDF Format |
| No. of Pages | : 17 |
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Abstract
The impact of embedded location options on Indian agricultural commodity futures returns has not been investigated systematically, despite the available anecdotal evidence suggestive of significant impact. Any significant impact on futures returns translates directly to an impact on hedging effectiveness of the futures. This paper investigates whether the addition of a return term due to the location option helps in explaining futures returns better relative to cash market and storage returns alone for the Chana contract when using regression analysis. Relative importance analysis is used to assess the relative contributions of regressors, and regression coefficients are tested for significance. It is found that the adjusted coefficient of determination improves significantly on adding location option returns as a regressor, and its regression coefficient is significant for the majority of the contracts studied. Relative importance analysis of the regressors shows that location option, on average, accounts for 28% of the explained variability of excess futures. These results suggest that location option impacts futures prices and returns significantly and is a key reason for the poor hedging effectiveness of Indian agricultural commodity futures. These results guide exchanges, regulators and policymakers to reduce the impact of embedded location options by optimizing contract delivery specifications to make futures contracts more useful to hedgers such as farmer producer organizations.
Introduction
The agricultural commodity futures market is one of the oldest traded markets in India, having existed since the 19th century. Cotton, oilseeds, jute and wheat contracts have been traded at various times since the 20th century (Harikumar and Manoj-Narayanan, 2017) on regional exchanges. In the year 2003, several policy changes brought liberalization of trading
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