Financial Instruments to Hedge Commodity Price Risk for Developing Countries

22 Pages Posted: 25 Jan 2008

See all articles by Yinqiu Lu

Yinqiu Lu

International Monetary Fund

Salih N. Neftci

CUNY Baruch College

Date Written: Janurary 2008

Abstract

Many developing economies are heavily exposed to commodity markets, leaving them vulnerable to the vagaries of international commodity prices. This paper examines the use of commodity options - including plain vanilla, risk reversal, and barrier options - to hedge such risk. It then proposes the use of a new structured product - a sovereign Eurobond with an embedded option on a specific commodity price. By extracting commodity price risk out of the bond, such an instrument insulates the bond default risk from commodity price movements, allowing it to be marketed at a lower credit spread. The product is also designed to help developing countries establish a credit derivatives market, which would in turn enhance the marketability and liquidity of sovereign bonds.

Keywords: Commodity markets, Bonds, Revenues, Prices, Developing countries

Suggested Citation

Lu, Yinqiu and Neftci, Salih N., Financial Instruments to Hedge Commodity Price Risk for Developing Countries (Janurary 2008). IMF Working Paper No. 08/6, Available at SSRN: https://ssrn.com/abstract=1087185

Yinqiu Lu

International Monetary Fund ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Salih N. Neftci (Contact Author)

CUNY Baruch College ( email )

17 Lexington Avenue
New York, NY 10021
United States
(212) 817-8261 (Phone)
(212) 817-1514 (Fax)

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
1,180
Abstract Views
6,185
Rank
36,320
PlumX Metrics