Publication

In 1997 the Chicago Mercantile Exchange replaced its live hog futures contract with a cash-settlement mechanism based on a Lean Hog Index. Producers and packers are concerned convergence between cash and futures prices is not occurring and that basis volatility has increased in recent years. Our results indicate that basis has widened and its variability prior to expiration has increased in the cash-settlement period. Despite some evidence that ex-ante basis risk has increased, the ability to forecast basis prior to expiration has not decreased appreciably with cash settlement. In the absence of forecasting procedures, producers and market participants have experienced additional variability in their selling prices. Hedging generally reduces the variability in cash prices, but its ability to do so has declined during the cash-settlement period due to increased basis variability.