Financial Markets for Commodities

6 A Selective Review of Classic Literature in Economics

Of what use is hedging? We have chosen three authors to help illustrate the “classic” responses to this question. We will first speak of classic literature because contemporary work is carried out within the broad outlines created by these authors:

• – Holbrook Working turned hedging into an object of study in economics. Working had been an extremely close observer of the functioning of futures markets and wanted to give a theoretical interpretation of this functioning. His central conclusion, which was quite unorthodox, was that hedging was primarily used to speculate and that protection against price risk was only an incidental benefit;
• – Leland L. Johnson conceived of representing hedging within the framework of an expectation-variance model that was quite standard. Contrary to Working, Johnson considered that hedging was primarily used to transfer risks from agents who sought to protect themselves toward agents who were ready to take risks, leveraging the expectation of remuneration. Johnson also produced a vast amount of literature on the optimal hedge: what ratio of hedging must an agent choose, based on the economic goals they want to achieve?
• – Jerome Stein explored the simultaneous determination of the equilibrium price on cash markets and on futures markets, positioning himself within the conceptual framework of expected utility. He offered one of the first responses that economists considered essential: how are ...