Effectiveness of Naive Class III Hedging Strategies
Published : Nov 2004
Authors : Ed Jesse, Jacob Schuelke
Dairy price risk management educational programs stress developing and following a marketing plan that identifies price levels triggering certain actions. Risk managers are urged to monitor markets closely and modify their marketing plans in light of changing market conditions. That is very good advice. Unfortunately, few follow it. This raises the question of whether less sophisticated hedging or forward contracting strategies might benefit dairy farmers who don't follow markets closely. For example, could a dairy farmer place a standing order with a broker to systematically take certain actions that would increase or stabilize returns relative to "taking the market?" Note that this kind of action would still represent a marketing plan, but one with static rather than evolving price goals or other hedging triggers. In this paper, we look at the results of some systematic, or naive, hedging strategies based on the Class III milk contract. These strategies were simulated over the period January 2000 (when the Class III contract first traded) through September 2004. Class III prices ranged from $8.57 to $20.58 per hundredweight during this time. This makes it a good period for testing systematic strategies that might be attractive only during times of high or low milk prices.

