Integrated production and risk hedging with financial instruments

Abstract

We review the existing literature on integrated production and risk hedging with forwards/futures and options for a risk averse firm in single and multi period settings. We illustrate the value of hedging joint price, basis, and yield risks using forwards/futures and options. Then, we analyze the procurement problem of a risk neutral commodity producer who sells via a long-term fixed-price contract, fulfilling buyer's stochastic demand and intelligently trading in the spot market. We solve a continuous time, infinite horizon stochastic control problem in order to determine the optimal policy for production and spot market trading.