When compared with prices on the CBOT and the LIFFE, Polish wheat prices exhibited strong changes in variation from year to year. For example, during the time period covered, price variation as measured by the coefficient of variation ranged from 4.2% to 27.7% in Poland while the coefficient of variation over the same period of time on the CBOT was 8.0% to 15.1%.

This price variability over time represents great price risk for those who operate on the Polish wheat market. It also indicates a need for using effective risk management tools. Clearly under such conditions alternatives such as hedging with derivatives that are already available in Western markets should be examined.

# **2.2. Spatial Variation**

Figures in Table 2 show that based on measures of spatial variation of the wheat prices, considerable differences between voivodships can be observed. The main observations are as follows:

- a) Price differentiation among the 49 voivodships is very high. This can only partly be explained by the cost of grain transportation which within Poland usually does not exceed roughly 8% to 10%9 of the total value of the grain transported. The measured difference between the lowest and highest price for any one month is very often over 20% and in fact, the overall average price differential for the 1990-1995 period is 40%. This level of price difference would indicate that prices within Poland are not integrated to the degree that normal efficiencies would suggest.

- b) Large differences in price levels could especially be observed in 1990. This is understandable as it was the first year of free market economy reforms in Poland, and different markets which started to develop showed very little stability.

- c) During the whole period of analysis, 1990-95, the spatial variation of the wheat prices has been declining, although, it still remains very high. This declining trend might imply that there are some improvements in the market efficiency, but this process is not progressing well enough to assure for a quick spatial price adjustments.

- d) Price levels in certain months differ much more than in some others; generally prices in winter months as well just before harvest time are more volatile than during and after the harvest time. There are, however, some exceptions depending on the particular year.

# **3. Basis Risk Analysis**

Basis risk analysis refers to the risk associated with price risk management practices whereby a firm will hedge the physical cash price risk in a derivative futures market. For example, a firm that has purchased physical cash wheat will sell an equal and offsetting amount of futures contracts in an established futures exchange. This enables a firm to protect itself from potential price declines. If there is a strong price relationship between the physical cash market and the futures market, price changes in the physical cash market will be reflected in the futures market. In essence, the firm has shifted its risk of declining prices to the futures market (of course, the firm has also foregone the opportunity to benefit from price increases). This risk shifting process is one of the primary values 9 Based on interviews with industry participants and transportation firms.