IMPLICATIONS OF CROP YIELD AND REVENUE INSURANCE FOR PRODUCER HEDGING

New types of crop insurance have expanded the tools from which crop producers may choose to manage risk. Little is known regarding how these products interact with futures and options. This analysis examines optimal futures and put ratios in the presence of four alternative insurance coverages. An analytical model investigates the comparative statics of the relationship between hedging and insurance. Additional numerical analysis is conducted which incorporates futures price, basis, and yield variability. Yield insurance is found to have a positive effect on hedging levels. Revenue insurance tends to result in slightly lower hedging demand than would occur given the same level of yield insurance coverage.Risk and Uncertainty,

EVALUATION OF HEDGING IN THE PRESENCE OF CROP INSURANCE AND GOVERNMENT LOAN PROGRAMS

This research evaluates the interaction of new alternative insurance designs, forward pricing tools and the government revenue protection program while assuming a government loan program is in place. A numerical analysis is conducted using a revenue simulation model that incorporates futures prices, basis, and yield variability. Three crop insurance designs at 75 percent of yield guarantee are evaluated. Optimal futures and at-the-money put option hedge ratios are derived for expected utility maximizing of soybean producers. Sensitivity to loan rate levels are examined. Our results suggest that loan programs profoundly alter the optimal producer strategy.Agricultural Finance, Marketing,

Managing Risk in Farming: Concepts, Research, and Analysis

The risks confronted by grain and cotton farmers are of particular interest, given the changing role of the Government after passage of the 1996 Farm Act. With the shift toward less government intervention in the post-1996 Farm Act environment, a more sophisticated understanding of risk and risk management is important to help producers make better decisions in risky situations and to assist policymakers in assessing the effectiveness of different types of risk protection tools. In response, this report provides a rigorous, yet accessible, description of risk and risk management tools and strategies at the farm level. It also provides never-before-published data on farmers' assessments of the risks they face, their use of alternative risk management strategies, and the changes they would make if faced with financial difficulty. It also compares price risk across crops and time periods, and provides detailed information on yield variability.crop insurance, diversification, futures contracts, leasing, leveraging, liquidity, livestock insurance, marketing contracts, options contracts, production contracts, revenue insurance, risk, vertical integration, Farm Management, Risk and Uncertainty,

Hedging Potential in Grain Storage and Livestock Feeding

The potential for shifting risk through hedging in commodity futures is analyzed for selected grain storage and livestock feeding situations. Results applying to various locations, grades, and/or classes are reported for wheat, corn, oats, cattle, and hogs. Hedging potential is measured in terms of risk-shifting effectiveness--the proportional reduction in the variance of profits that can be obtained through routine hedging. The study indicates that hedging provides an effective means of shifting risk in livestock feeding as well as in grain storage. For most of the situations studied, the level of hedging that minimizes overall profit risk ranges between 0.6 and 1.0 unit of futures per unit of cash commodity. About one-third to two-thirds of the price risk can be shifted through hedging at this level. Hedging effectiveness declines as the distance from the delivery point for the futures contract increases. Hedging effectiveness differs between classes of wheat and among the three wheat futures markets. Grade has little impact on hedging effectiveness in cattle feeding, however. Optimal hedging levels for individual firms are shown to be very sensitive to the firms’ price expectations

Optimal Hedging Levels and Hedging Effectiveness in Cattle Feeding

Optimal hedging level, minimum-risk hedging level, and hedging effectiveness are defined in a manner consistent with portfolio theory and used to analyze hedging potential in cattle feeding. Estimated upper limits on optimal hedging levels ranged from 0.56 to 0.88 unit of short futures per unit of four types of slaughter cattle produced at five locations. When futures trading costs are taken into account, optimal hedging levels are depressed below these limits, depending upon the resource availabilities and profit expectations of individual firms. Location, grade, and sex of the cattle fed have small effects on optimal hedging levels and hedging effectiveness

MINIMUM RISK PRE-HARVEST SALES OF SOYBEANS

The formula developed by McKinnon for determining minimum risk forward selling levels for crop producers operating under yield risk is modified so that basis risk can also be taken into account. Example results were presented for soybeans for selected Corn Belt counties using both the modified McKinnon method and an alternative method involving the direct minimization of variance of return

Differences Among Commodities in Real Price Variability and Drift

Many farm products exhibit price variabilities over over long time intervals that range between 10 and 20 percent when measured as standard deviations of annual rates of change. Price variability is notably higher for onions, rice, wool, oats, potatoes, grapefruit, and oranges, and lower for snap beans, tobacco, green peas, milk, broccoli, processing tomatoes, and strawberries. Price variability was higher during 1977-93 than during 1949-72 for grains, soybeans, and peanuts, lower for grapes, potatoes, processing tomatoes, and hogs, and about the same for other crops and livestock. Real prices fell between 1948 and 1993 for 29 of 30 commodities studied, with poultry, eggs, wool, snap beans, grains, and cotton exhibiting the largest rates of decline