Hedging price risk when no direct hedge vehicle exists: the case of silicon

Abstract

Silicon has wide applications in the electronic, ferrous foundry and chemical industries but does not possess a well-developed forward or futures market. Here we investigate potential candidates to cross-hedge silicon’s price risk. Our results show that a proxy for a newly introduced Chicago Mercantile Exchange (CME) ferrous contract, iron and steel scrap, explains close to 60% of the variation in silicon price changes. Estimated Generalized Least Squares (EGLS) estimations of hedge ratios are shown to produce more consistent hedge-effectiveness over OLS counterparts. Thus, it appears that the ferrous contract could fulfil this role.

Keywords:

• silicon
• ferrous scrap
• futures
• hedging-effectiveness

JEL Classification:

• G13
• G32
• L61

Notes

¹ A recent US Geological Survey (2011) finds that only about 2% of total elemental Silicon (5–10% of metallurgical grade silicon) is used in electronics (also see Sidor et al. (2012), Cahn (2009) and Emsley (2011)).

² For more information see the CME press release, ‘CME Group Announces Launch of US Midwest Scrap (AMM) Futures’, 17 August 2012.