Segmenting Supply Chain Risk Using E/CTRM Systems: Unifying Theory of Commodity Hedging and Arbitrage

Abstract:     
The complexity of managing physical and financial risk throughout the commodity production, processing and merchandising chain presents numerous challenges. To solve this problem commercials are increasingly turning to Energy and Commodity Transaction Risk Management (E/CTRM) systems. Still, risk management functionality within these systems is reported as falling short of requirements. Our discussion, in response, provides an economic framework for developing commodity risk policy and evaluation tools. In doing so, we unify the theory of normal backwardation with theory of storage, macroeconomic general equilibrium with multiple equilibria and microeconomic agents, basis trading with arbitrage strategies, and the hedging response function with elastic/inelastic supply-demand economics. After establishing axioms and rules of inference, we investigate the agribusiness supply chain to help illustrate application.

Number of Pages in PDF File: 51

Keywords: Agribusiness, Arbitrage, Backwardation, Basis Risk, Contango, Cost-of-Carry, Equilibrium, Expectations Theory, Hedging Pressure, Multiple Equilibria, No-Arbitrage Bounds, Supply Chain, Term Structure, Theory of Storage

JEL Classification: D82, D84, E12, G13, L92, O13, Q11, Q12, Q13, Q14, Q15, Q16

working papers series