Working Paper: CEPR ID: DP7513
Authors: Eduardo Borensztein; Olivier Jeanne; Damiano Sandri
Abstract: This paper uses a dynamic optimization model to estimate the welfare gains of hedging against commodity price risk for commodity-exporting countries. We show that the introduction of hedging instruments such as futures and options enhances domestic welfare through two channels. First, by reducing export income volatility and allowing for a smoother consumption path. Second, by reducing the country's need to hold foreign assets as precautionary savings (or by improving the country's ability to borrow against future export income). Under plausibly calibrated parameters, the second channel may lead to much larger welfare gains, amounting to several percentage points of annual consumption.
Keywords: Commodity Exports; Default; Futures; Hedging; International Reserves; Options; Precautionary Savings
JEL Codes: C61; E21; F30; F40; G13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Hedging instruments such as futures and options (G13) | Enhanced domestic welfare (I38) |
| Reduced export income volatility (F14) | Lower consumption volatility (D11) |
| Lower consumption volatility (D11) | Increased welfare (I38) |
| Hedging (D81) | Improved external balance sheet (G32) |
| Improved external balance sheet (G32) | Reduced need for precautionary savings (E21) |
| Improved external balance sheet (G32) | Increased ability to issue more default-free external debt (F34) |