To Process or Not to Process:

This paper examines the implications of the production transformation asymmetry on prices of the commodity relative to the prices of its derivative products. When the production transformation process of a harvested good is irreversible, the price linkage between the harvested good and its derivatives breaks. This happens in the case where the supply of the good declines significantly and when independent demand for the good exists. Because the price of the good can rise above the combined value of its derivatives, it is associated with a valuable option not to process. The equilibrium processing margins are derived within a three period model. We show that the option not to process is valuable and can only be exercised by those who carry the commodity. Furthermore, it is shown that a partial hedging strategy is sufficient to reduce all price risk and it is superior to a strategy of no hedging. Preliminary results from the soybean complex support our predictions. JEL Classification G13 Kewords: Production transformation, irreversibility, crush margin, soybean complex, hedging