SOUTHERN JOURNAL OF AGRICULTURAL ECONOMICS
DECEMBER, 1973
LOCATION BASIS VARIABILITY EFFECTS ON
SLAUGHTER CATTLE HEDGING IN THE SOUTH AND SOUTHERN PLAINS*
Barry W. Bobst
Location basis variability is a matter of potential
concern to livestock producers who contemplate the
use of Bvestock futures contracts as hedging devices
and who are removed from a designated futures
contract deBvery point. Recent attention has been
given this problem by Heifner [3] in an analysis of
minimum-risk hedging ratios for cattle and hogs,
among other commodities, in which measures of
risk-shifting effectiveness were generated for
comparison among locations. Heifner found no
significant differences among locations for either
cattle or hogs, indicating that location basis
VariabiBty is not a significant factor for these
commodities. Using a somewhat different approach,
and a different set of markets and time frame, the
author [1] Cametothesameconclusionforslaughter
hogs in the South. Results obtained for slaughter
cattle, however, are somewhat at variance with the
findings reported by Heifner. These results and their
interpretation are the subject of this paper.
The concept of location basis variability is fairly
straight-forward. Location basis is the price
differential between a local cash market and a futures
contract deBvery point. Basis VariabiBty results from
fluctuations in this differential. Hedgers who have
access to the dehvery market tend to be insulated
from its effect by the deBvery option and the
consequent tendency for cash and futures prices to
converge as futures contracts mature. For hedgers in
distant markets, however, deBvery is not a practical
option, so that any difference between the price
differential expected at the placement of a hedge and
the actual differential experienced upon Bfting it
causes a deviation in results from those anticipated.
Thus, location basis VariabiBty can add an increment
of risk for the distant hedger, reducing the
effectiveness of hedging as a risk-averting device.
Location basis variability is not theoretically
inherent in the situation of a distant hedger but
depends rather on the nature of spatial competition.
In perfectly competitive spatial markets, price change
wi∏ be reflected simultaneously across the spatial
price surface, leaving differentials along the surface
unchanged. These differentials reflect spatial patterns
of supply and demand and transfer and exchange
costs. In theory, they change only as these underlying
factors change. In the real world, however, leads and
lags in price change can occur, and some markets may
be isolated from minor price fluctuations that occur
in others. In a broad national market such as exists
for beef cattle, price differentials tend to be
maintained over time, but this does not exclude the
ρossibiBty of temporary fluctuations which could
cause location basis variability to occur.
The existence and magnitude of location basis
VariabiBty is, therefore, an empirical question. While
there are a number of ways to measure location basis
VariabiBty, the method adopted in this study was a
direct comparison of hedging revenue variances. If it
can be shown that price variances among markets are
not significantly different from one another, then
differences in hedging revenue variances between a
dehvery point market and distant markets can be
ascribed to location-related factors. To anticipate a
bit, no significant differences in cash market price
variances for choice steers were found among the
markets studied, but significant differences in hedging
revenue variances were found.
Barry W. Bobst is associate professor of agricultural economics at the University of Kentucky.
‘Kentucky Agricultural Experiment Station Article No. 73-1-74.
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