Hedging Revisited: Resolving Contractual Conflicts

by

Joost M.E. Pennings
Department of Agricultural and Consumer Economics
University of Illinois at Urbana-Champaign

and

Raymond M. Leuthold
Department of Agricultural and Consumer Economics
University of Illinois at Urbana-Champaign

Abstract

This paper develops an alternative view on the motivation to hedge. A conceptual model shows how hedging facilitates contract relationships between firms and can solve conflicts between firms. In this model, firms' contract preferences, level of power and conflicts in contractual relationships are driving usage of futures contracts. The model shows how using futures markets can provide a jointly preferred contracting arrangement, thereby enhancing relationships between firms. The robust nature of the conceptual model is empirically examined through a computer-guided study of various firms.

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