Will hedging joint cocoa price and production risk benefit Ghana?

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Ashesi University College, published by Mot Juste
This paper assesses the usefulness of risk hedging on futures markets for a cocoa exporter subject to concurrent price and output (revenue) risks. The analysis is conducted for Ghana, the world’s second largest exporter of cocoa beans. Using cocoa export revenue data, the cocoa exporter’s utility maximization problem (UMP) is solved using a Constant Relative Risk Aversion (CRRA) utility function due to Nelson and Escalante (2004) which displays risk vulnerability. Risk vulnerability is the most natural restriction on preferences (Gollier and Pratt, 1996). Simulation results from solving the UMP indicate that as a result of production risk, optimal revenue hedge ratios are much smaller than optimal price risk hedge ratios for reasonable values of the risk parameter. When transaction costs are incorporated into the hedger’s UMP , optimal revenue hedge ratios decline further although they remain positive. The findings indicate that limited use of the futures market is optimal for Ghana because it improves cocoa exporter utility relative to the unhedged position. These results should provide valuable information to policy makers in Ghana and other cocoa producing countries because they confirm that revenue risk hedging is a viable risk management alternative even when transaction costs are accounted for in the UMP of the hedger.
Ghana, cocoa, transaction costs, hedge ratio, risk vulnerability
Armah, S. E. (2012) “Will hedging joint cocoa price and production risk benefit Ghana?” Ashesi Economics Lectures Series Journal. 1, (1): 47–64