The purpose of the paper is to reexamine cash settlement of lean hog futures contracts as a
hedging tool, focusing on basis behavior and management of basis risk. To understand the
dimensions of the situation, first we compare hog futures contract basis level, variability, and exante
basis risk measured in terms of forecast ability between physical delivery and cash
settlement using data from 1985 to 2008 on hog cash and future prices. We then examine the
hedging usefulness of the current CME lean hog index and provide an alternative hedging
instrument—a regional basis contract—that takes into account location differences between
regional cash prices and the CME lean hog index. Our results indicate that basis has widened and
its variability prior to expiration has increased in the cash settlement period. However, we find
no evidence to suggest that ex-ante basis risk has increased, meaning that the ability to forecast
basis prior to expiration has declined little with cash settlement. Routine hedging with futures
contracts as expected reduces the variability in returns compared to cash sales. Including
location differences further reduces the variability in cash prices. Our results should be of value
to users of the hog futures markets and market analysts that offer pricing advice.