Multiperiod Production with Forward and Options Markets
Sergio H. Lence, Yong Sakong, Dermot J. Hayes
August 1993 [93-WP 112]
Lence, S.H., Y. Sakong, and D.J. Hayes. 1993. "Multiperiod Production with Forward and Options Markets." Working paper 93-WP 112. Center for Agricultural and Rural Development, Iowa State University.
Production and hedging in both forward and options markets are analyzed for forward-looking firms that maximize expected utility. In the presence of unbiased forward and options prices, it is shown that such firms will use options as hedging instruments. This result contrasts with the conclusions from studies that assume myopic behavior, and occurs because forward looking agents care about the effect of future output prices on profits from future production cycles. Simulations support the theoretical results and show how the introduction of an options market influences the optimal forward position.