Exploring the futures hedging possibilities for the Norwegian lumber market, using the U.S. market as a proxy. Testing the effectiveness of different minimum variance hedge ratio approaches
Master thesis
Submitted version
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https://hdl.handle.net/11250/3030731Utgivelsesdato
2022Metadata
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Sammendrag
This paper explores the possibility for a cabin producer to manage lumber price volatility by
hedging with futures contracts. Our intention is to explore if the introduction of a futures
market for lumber will provide Norwegian (and European) producers with a viable way to
handle said volatility. With a set of simplifying assumptions, a minimum variance strategy is
tested on an artificially constructed cabin producer to estimate the effectiveness of such a
strategy. Estimating the minimum variance hedge position is done using two advanced
autoregressive models, in addition to a simpler, unconditional model. The three approaches
are compared in a segmented time-series to isolate the effectiveness prior to and after the
price shock that came with the Covid-19 pandemic.
The findings indicate that the hedging strategy has great potential of reducing the variance of
the cash flows. Prior to the Covid-19 outbreak, the variance of the cash flows could have
been reduced by almost 50 percent. In that period, all three estimation models achieved
almost identical effectiveness, with all three being within three percentage points of each
other. Following the Covid-19 outbreak, there is a greater spread between the approaches,
with the surprise being that the simpler, unconditional model outperforms the autoregressive
models. The inferior performance of the conditional models indicates a weakness in the
models’ ability to estimate the optimal hedge position in times of sustained increased volatility.