Toward a Positive Economic Theory of Hedging

The hedging models developed over the last half century are evaluated for their ability to explain the actual hedging behavior of the various economic agents. This evaluation shows a total lack of a reasonable positive model of hedging behavior. While each class of existing models predicts some observed behavior, none is able to predict the broad range of actions that is easily observed in the real world. In this paper I develop such a model and include a plausible and coldly rational economic explanation for why farmers don't hedge at all while merchandisers with identical risk attitudes will fully hedge.