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Staff Paper No. 504 - Abstract

Risk Premiums and the Storage of Agricultural Commodities

Hua Lin
T. Randall Fortenbery [trforten@wisc.edu]

Staff Paper No. 504, December 2006, 35p.

Abstract

The existence of a commodity market risk premium has attracted the interest of researchers for several decades. Most attempts to measure risk premiums have been focused on futures markets. However, if the risk premium is a payment made by hedgers (as suggested by Keynes) to reduce their risk profile, then the risk being reduced originates in the cash market. This suggests that the risk premium may also originate in the cash market. As such, the search for a risk premium should focus on the cash market, and, given Working’s Supply of Storage Curve, should be measured as a function of stored inventory. This paper develops an expected utility based model that separates the risk premium from other storage incentives, and illustrates the role of the cash market risk premium on the storage decisions of two different market agents.
Last updated on Tue, Dec 19, 2006 2:25pm