Futures versus Share Contracting as Means of Diversifying Output Risk
David Hirshleifer and Avanidhar Subrahmanyam
Economic Journal, May 1993
Two means by which commodity producers can reduce their exposure to quantity risk are share contracting and futures hedging. This paper explains the coexistence of these arrangements by showing that these will normally be complementary means of transferring risk. Share contracting by a purchaser with many producers can help diversify imperfectly correlated quantity risks. Futures contracts, on the other hand, hedge the systematic but not the idiosyncratic components of output risk. Thus, futures hedging helps to ameliorate the main disadvantage of multiple share contracting, an excessive loading of systematic risk on the purchaser.