An Analysis of Risk and Return in Hog Finishing

Abstract

The objectives of this study were to measure returns and the variation in returns for hog finishers in Alberta. From this base, different strategies were assessed as to their ability to reduce the level of price risk faced by producers. The National Tripartite Stabilization Program was reviewed along with hedging strategies using the Chicago Mercantile Exchange Live Hogs futures. Risk was measured using the Mean Square Error (MSE) and the Capital Asset Pricing Model (CAPM) beta. A twelve month rolling average of nearby basis was used to predict hog prices. All of these strategies studied, the NTSP, a selective investment model, a 100% hedge and an optimal hedge, reduced risk compared to the base model. The 100% hedge reduced risk to the greatest extent. The NTSP alone reduced risk and increased returns. When using the Capital Market Line as a means of measuring the risk return tradeoff, all the strategies provided a viable alternative for risk reduction compared to the base model. The CAPM betas for the various strategies were very low. Hog finishing could provide a diversification opportunity for holders of a market portfolio.