NCCC-134
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Options Portfolios in the Presence of Non-Linear Risk
Kevin McNew
Year: 1996
 

Abstract

Options on futures give hedgers a way to construct a risk management portfolio which has similar properties to the risk they face in the cash market. Of particular importance is the benefit that options provide when the cash position value is non-linearly related to the futures price. Such a situation is particularly prevalent for grain producers who face random cash prices and output. This study presents two methods for constructing an options portfolio composed of different strike prices. An empirical application for regional corn production in the U.S. demonstrates that both methods are similar in terms of risk reduction and, in some instances, provided significant improvements from using futures.

 
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Noise Trader Demand in Commodity Futures Markets
Dwight R. Sanders, Scott H. Irwin, and Raymond M. Leuthold
Year: 1996
 

Abstract

Theoretical noise trader models suggest that uninformed traders can impact market prices. However, these models' conclusions depend on the assumed specification for noise trader demand. This research seeks to empirically determine the appropriate demand specification for uninformed traders. Using a commercial market sentiment index as a proxy for noise trader demand, a Granger causality model is estimated to examine the linear linkages between sentiment and futures returns. The results suggest that noise traders are positive feedback traders with relatively long memories.

 
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The Potential Inefficiency of Using Marketing Margins in Applied Commodity Price Analysis, Forecasting, and Risk Management
Frank M. Han and Garth J. Holloway
Year: 1996
 

Abstract

This paper examines the implications of using marketing margins in applied commodity price analysis. The marketing-margin concept has a long and distinguished history, but it has caused considerable controversy. This is particularly the case in the context of analyzing the distribution of research gains in multi-stage production systems. We derive optimal tax schemes for raising revenues to finance research and promotion in a downstream market, derive the rules for efficient allocation of the funds, and compare the rules with an without the marketing-margin assumption. Applying the methodology to quarterly time series on the Australian beef-cattle sector and, with several caveats, we conclude that, during the period 1978:2 - 1988:4, the Australian Meat and Livestock Corporation optimally allocated research resources.

 
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An Empirical Examination of the Role of Trading Volume in Futures Markets
Li Yang and Raymond M. Leuthold
Year: 1996
 

Abstract

This paper investigates the trading profits and the informational role of trading volume in the frozen pork bellies futures market for reporting traders from the period 1985 through 1994. More than 95% of reporting traders make statistically zero profits on a daily basis. About half of the remaining reporting traders make positive profits and the other half percent earn negative profits consistently. Given the evidence on the examination of the relationship between trading volume and daily profits for winning traders, there is little support for the theoretical finding that traders who use information contained in trading volume do better than traders who do not. Hence, it is not clear whether trading volume provides useful information for frozen pork bellies traders to earn consistently positive returns on a daily basis.

 
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Wheat Futures Price Behavior: Theoretical and Empirical Considerations
Dawn D. Thilmany, Jau-Rong Li, and Christopher B. Barrett
Year: 1996
 

Abstract

This study analyzes the time series statistical properties of wheat futures prices to determine whether price behavior differs among intramarket contracts. We argue that the differential role of inventories, information, hedging objectives and probability of stockout across seasons provide a theoretical basis and empirical interest for finding such a difference. The behavior of May and September futures prices are indeed found to be significantly different and in ways consistent with theory. Furthermore, an endogenous contract arrival effect is found for both contracts, demonstrating the importance of developing models which incorporate market activity proxies.

 
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Volatility Based Tests for Informational Efficiency on Commodity Options Markets
Robert J. Myers, Steven D. Hanson, Jing-Yi Lai, and Hong Wang
Year: 1996
 

Abstract

This paper has two objectives. The first is to develop a simple, computationally tractable procedure for estimating implied GARCH volatilities from commodity options price data. The second is to apply this procedure to elicit implied volatilities from soybean option price data and investigate how well the resulting volatility forecasts predict ex-post "realized" volatilities. We find that filtering option prices through a GARCH option pricing model provides informative forecasts of daily volatilities, but that these forecasts can generally be improved upon using additional information available at the time the options are being priced. The results have implications for forecasting volatility, as well as for the informational efficiency of soybean options markets.

 
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Commodity Futures Market Reaction to Anticipated Public Reports: Frozen Pork Bellies
Li Yang
Year: 1996
 

Abstract

This paper investigates the reaction of the frozen pork bellies futures market to the release of inventory information. Knight-Ridder releases their analysts' forecasts two days prior to the estimates provided by USDA. The model provides a direct link between analysts' forecasts, the USDA estimates, and traders' beliefs on the frozen pork bellies inventories in storage. It differs from previous studies in that the price reaction depends on the information content of the difference between the USDA estimates and the analysts' forecasts, and on the dispersion among the analysts' forecasts. It is shown that empirical tests based solely on the information content of the forecasts induce possible measurement error and result in the biased findings.

 
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Price Discovery Role of Futures Prices: A Linear Feedback Approach
Samarendu Mohanty, Darnell B. Smith, and E. Wesley F. Peterson
Year: 1996
 

Abstract

This paper measures the degree of dependence between cash and futures prices for corn and soybeans using a linear feedback approach. The degree of dependence between these two series is decomposed into two directional and one contemporaneous feedback. These feedbacks are used to provide evidence of the price discovery role of futures price and also market efficiency. The feedback results suggest that the soybean futures market is more efficient than that of corn. Regarding the price discovery role of futures prices, one might argue for the price discovery role of corn futures, even though the directional feedback from futures to cash price was estimated to be only 5 percent. In the case of soybeans, the price discovery role of futures prices can only be argued if one can justify the causal ordering of contemporaneous feedback from futures to cash prices.

 
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Evaluation of Extension and USDA Price and Production Forecasts
Terry L. Kastens, Ted C. Schroeder, and Ron Plain
Year: 1996
 

Abstract

This study evaluates Extension forecasting accuracy in an analysis of responses to the Annual Outlook Survey conducted by the American Agricultural Economics Association from 1983 through 1995. Representative and composite production and price forecasts for several commodities are examined. Extension forecasts are compared with USDA, naive, and futures-based forecasts. Relationships between forecast/forecaster features and accuracy are examined in a regression framework. Composite forecasts are more accurate than representative forecasts. Generally, Extension forecasts are less accurate than USDA forecasts for crops, but more accurate for beef production and price. Forecasters who rely more heavily on formal econometric models are slightly more accurate than those who do not.

 
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Spatial Price Analysis: A Methodological Review
Paul L. Fackler
Year: 1996
 

Abstract

Empirical methods of dynamic spatial price analysis are reviewed. Emphasis is given to interpreting these methods in the context of economic models of price determination, including both point-location and agents-on-links models. This focus calls into question or sheds new light on a number of standard practices, including the market integration criteria of Ravallion and Timmer, the use of impulse analysis and Granger-causality.

 
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Determination of Base Payments for Feeder Pig Producers and Finishers
Joseph L. Parcell and Michael R. Langemeier
Year: 1996
 

Abstract

This study examines the level of base payments required to make feeder pig finishing and producing contracts comparable to independent production performance. Stochastic dominance with respect to a function is used in the comparisons between contract and independent production. Required payments for risk averse feeder pig finishers and producers with average production efficiency are similar to those currently offered by contractors. Producers with above average production efficiency or who were risk neutral require payments well above current contract rates, before they would prefer contracting.

 
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Effects of Reduced Government Deficiency Payments on Post-Harvest Marketing Strategies
Steven Betts, Brian D. Adam, and B. Wade Brorsen
Year: 1996
 

Abstract

Effects of reducing government deficiency payments on a wheat producer's post-harvest marketing strategies are evaluated. The deficiency payment is predicted using an average option pricing model to properly value both intrinsic and time values of the deficiency payment. The biggest loss to producers from reducing deficiency payments is in reduced revenue. Although the deficiency payment helps reduce revenue risk, marketing strategies are available that can reduce risk nearly as well as the deficiency payment program can. Some producers will compensate for reduced deficiency payments by increasing use of futures and options contracts. For others, however, the optimal strategy is to sell wheat at harvest, because of high opportunity cost, storage cost, or risk aversion. For those producers, the uncertain deficiency payments increase variability of returns, or risk. Reducing payments reduces this risk, and leads to decreased use of futures and options contracts.

 
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Optimal On-Farm Storage
Paul L. Fackler and Michael J. Livingston
Year: 1996
 

Abstract

When transactions costs prohibit an agricultural producer from replenishing grain stocks during the post-harvest marketing season, sales out of storage may be viewed as irreversible investments. The irreversibility of sales decisions transforms the dynamic marketing problem into one that is analogous to the optimal exercise of a financial option. A procedure is developed to solve the producer's marketing/storage problem and is applied to the cases of North Carolina and Illinois soybeans. Decision rules derived from this procedure are shown to be practically significant relative to simple marketing strategies that ignore the irreversible nature of the sales decision.

 
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Optimal Storage Decisions under Estimation and Prediction Risk
Tommie L. Shepherd and Jeffrey H. Dorfman
Year: 1996
 

Abstract

Estimation and prediction risk are shown to influence the optimal storage decision of a dominant firm facing a competitive fringe. The presence of risk with respect to demand estimation and supply prediction results in increased storage by a dominant firm exercising market power in a two period profit maximization scenario. Bayesian numerical integration is employed to derive the optimal storage decision for a hypothetical cooperative of Georgia pecan growers facing demand estimation risk, supply prediction risk and a combination of the two.

 
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You Know It's Going to Be a Bad Day When a 60 Minutes Camera Crew Is Waiting for You at Work - A Case Study of Chicken Contamination Publicity
Dean G. Fairchild and Roger A. Dahlgran
Year: 1996
 

Abstract

Adverse publicity about food contamination can depress demand, causing lost producer revenue. TV and print news coverage of bacterial contamination of chicken in the U.S. is incorporated into an inverse demand for chicken which is estimated using 1982 and 1991 data. A beta binomial audience-exposure distribution is used to estimate net reach and average frequency of exposure to contamination publicity. It was found that for each unit of increase in weekly publicity frequency, prices were depressed by 1.2 percent, leading to a $760 million retail loss to the chicken industry. This amounts to less than one-quarter of one percent of revenue over the ten years studied.

 
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Farmers' Use of Normal Flex Acres: A Glimpse of the Future
Brian Willott, Gary Adams, Robert Young, and Abner Womack
Year: 1996
 

Abstract

Given the new direction of farm policy, farmers in the future will be less constrained in making their planting decisions. This paper shows how farmers respond to market signals in allocating flex acres. By examining the five years of data that exist, researchers will begin to understand how producers may react when planting for the market prices and not for government subsidies. The estimated elasticities are much higher than those found in other studies.

 
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Textile Market Valuation of Cotton Quality Attributes
Changping Chen and Don E. Ethridge
Year: 1996
 

Abstract

This study analyzed cotton pricing structures associated with quality attributes at the end-use point of the U.S. cotton market using a hedonic framework for the 1992-1995 period. Results based on the information from primary market transactions show how the price of cotton is influenced by fiber attributes -- trash content, color, staple, fiber fineness and maturity, etc. The textile industry differentiates cotton by the region of origin in terms of fiber attributes. Fiber premiums and discounts were substantially different between the West and South Central regions. Staple premiums and discounts were different between the West and South. Micronaire discounts differed across all regions. This study provides the first objective evidence on cotton price-quality relationships at the end-use point of a cotton market that is based on bona fide market transactions.

 
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The Influence of IRS Tax Policy on Use of Livestock Cattle Futures and the Effectiveness of the Price Discovery Process
Wayne D. Purcell
Year: 1996
 

Abstract

Current IRS policy on deductibility of losses on futures trades discourages cattle feeders from being fully involved in the price discovery process. Analysis suggests the policy hurts the effectiveness of price discovery and imposes a cost on society at large. Cattle feeders are forced to make all adjustments in the cash side of their business by changing placements, and when negative margins are being offered, they must function as cash market speculators or allow unused capacity and absorb the costs of investment. There is no economically rational way cattle feeders can participate in the price discovery process under current IRS policy when the margins being offered are negative. A change in policy is proposed that would allow feeders to be long in cash cattle and/or distant live cattle futures up to feedlot capacity with losses in futures trades being treated as a deduction for tax purposes. The change should improve the price discovery process, produce a significant consumer surplus, increase market share for the beef sector, and it could increase revenues to the IRS. Conceptual and empirical support for a change in policy is presented. Research results that show the impact of different trader groups, including cattle feeders, on the effectiveness of price discovery are presented in support of the proposed change. More research on the impact of IRS revenues, where the results of a policy change are less definitive, and the related implications of the elasticity of demand for slaughter cattle is needed.

 
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Short-Run Captive Supply Relationships with Fed Cattle Transaction Prices
Clement E. Ward, Stephen R. Koontz, and Ted C. Schroeder
Year: 1996
 

Abstract

Questions have been raised about the impacts on spot market prices from meatpackers purchasing fed cattle two or more weeks in advance of slaughter. Three base models were estimated to study: (1) the relationship between use of captive supplies and fed cattle transaction prices; (2) the impact on fed cattle transaction prices from buyers having an inventory of fed cattle procured by captive supply methods from which to deliver cattle for slaughter; and (3) price differences between cash transaction prices and prices for fed cattle purchased under different captive supply methods. There was some evidence that impacts from either delivering cattle from an inventory of captive supplies or having an inventory of captive supply cattle were negative to small. Forward contract prices were found to be significantly lower than cash fed cattle prices.

 
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The Impacts of Exclusive Marketing/Procurement Agreements on Fed Cattle Transaction Prices: An Experimental Simulation Approach
Tracy Dowty, Clement Ward, Stephen Koontz, Derrell Peel, and James Trapp
Year: 1996
 

Abstract

The recent inclusion of exclusive marketing/procurement agreements between meatpacking and feedlot firms has created concern about how the level and variability of fed cattle transaction prices are affected. Existing agreements involve written or verbal contracts that allow the participating firms to market or purchase finished cattle at formula based prices for which the details are not made public. Exclusive marketing/procurement agreements were applied to an experimentally simulated fed cattle market. Two econometric models were developed from previous studies to evaluate price level and variability differences between active and non-active agreement periods. Price level and variability differences between the participating and non-participating firms of the agreements during the agreement and non-agreement periods were also evaluated. The effects of economically rewarding the subjects of experimental simulations studies on fed cattle transaction prices were evaluated. Results indicate that participants of exclusive marketing/procurement agreements realized significantly lower price means and variances than non-participating firms. However, the mean and variance of market prices were found to be higher during the agreement periods than during the non-agreement periods. Economic reward and non-reward periods were not found to have significantly different price levels.

 
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Fed Cattle Geographic Market Delineation: Slaughter Plant and Firm Supply Response Analysis
Marvin Hayenga, Bingrong Jiang, and Donald D. Hook
Year: 1996
 

Abstract

The beef packing plant and firm spot market purchase volume responsiveness to relative prices paid by potential competitors was estimated to serve as one element in determining the relevant geographic market for fed cattle. Plant transaction data for one year was used, and an average of two significant competitors was found for each plant and firm. Volume sensitivities to price changes were quite large. Data limitations did not allow examining longer lagged purchase volume responses to relative price differences.

 
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Fed Cattle Spatial Transaction Price Relationships
Ted C. Schroeder
Year: 1996
 

Abstract

Delineation of geographic markets for fed cattle is essential in monitoring price behavior and determining the extent of spatial price parity. This study uses transaction data from 28 U.S. fed cattle slaughter plants to determine the extent of the geographic market for fed cattle. Results indicate a national market for fed cattle with prices across most plants cointegrated. In addition, price discovery originates predominantly at plants located in Nebraska and typically one-third of the total price adjustment to spatial integration occurs in one day.

 
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Arbitrage Costs Between Regional Fed-Cattle Markets
Stephen R. Koontz
Year: 1996
 

Abstract

Arbitrage cost models were used to measure the degree of integration between regional geographic AMS reported fed cattle markets. The method measures the implicit arbitrage costs and probability of arbitrage between two markets, and is also used to test the 5% rule from the Federal Trade Commission and Department of Justice Merger Guidelines. The results suggest that all U.S. fed cattle markets are well integrated. However, there are degrees of integration. East coast and west coast markets are distinct from markets in the central U.S. Further, arbitrage costs are lower from small volume markets to large markets, while costs are higher from large to small markets. Thus, for antitrust analysis, large market regions may be considered in isolation while small regions should include neighboring large regions in the economic market definition.

 
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Sources of Economic Variability in Cattle Feeding
Rodney Jones, James Mintert, Michael Langemeier, Ted Schroeder, and Martin Albright
Year: 1996
 

Abstract

Previous researchers have identified factors that contribute to variability of profits and feeding cost of gain in cattle feeding. Efforts have been made to identify the relative importance of specific factors in order to assist cattle feeders in managing economic risks. The results of this research suggest that these relationships are not stable over time, and are highly unpredictable. This implies that risk management strategies for cattle feeders may be more difficult to identify and implement than previously thought

 
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Improving Monthly Fed Cattle Forecasts with Information on Market-Ready Inventory
Kendall L. McDaniel and Stephen R. Koontz
Year: 1996
 

Abstract

Market-ready inventories are cattle which have reached an adequate degree of feeding finish but which have not been sold. The level of market-ready inventories appear to have an important impact on fed cattle prices, are discussed in industry and outlook publications, but have not been used in fed cattle price models. This work finds that incorporating measures of market-ready inventories into autoregressive models of monthly fed cattle prices will improve explanatory power but not the forecast performance of these models. Public data are insufficient for forecasting over this time horizon.

 
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An Economic Analysis of U.S. Broiler Industry: A Structural Bayesian VAR Approach
Chandrashekar Karnum, Christopher McIntosh, and Timothy Park
Year: 1996
 

Abstract

The U.S. broiler industry has seen major structural changes due to higher degrees of vertical integration and industry concentration. These structural changes have influenced the adjustment characteristics of key production variables to external disturbances. We examine these adjustment characteristics to external shocks in a dynamic context. A VAR approach was used to simulate the impulse response functions and forecast error variances. The results show that a positive feed cost shock leads to gradual declines in production and lagged increases in wholesale broiler prices. Shocks to wholesale prices yield a tepid production response. However, a sudden increase in production depresses the wholesale price of broilers. These results imply that feed cost increases pay a major role in the growth of the U.S. broiler industry. Improvements in feed conversion ratio, advances in production technology and adoption of better risk management practices at the national and farm level may help minimize the influence of feed cost.

 
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A Reappraisal of the Forecasting Performance of Corn and Soybean New Crop Futures
Carl Zulauf, Scott H. Irwin, Jason Ropp, and Anthony Sberna
Year: 1996
 

Abstract

This analysis evaluates the forecasting ability of the December corn futures contract and November soybean futures contracts during the previous spring. A regression equation is estimated which accounts for the well-known non-stationarity of commodity prices over the period 1952-1995. Results of this regression imply that the spring-time quotes of the corn and soybean harvest futures contracts are unbiased estimates of the prices at harvest. In addition, since 1974 the spring-time quotes are able to significantly predict the harvest-time quotes. This finding implies that farmers and others can use harvest futures at planting as a source of information concerning prices at harvest. Furthermore, in accordance with Stein, because the futures contracts are unbiased forecasts of realized prices, then the corn and soybean futures markets are functioning well in the sense that only unavoidable social loss exists. Magnitude of the unavoidable loss is measured by R2. R2 increased for corn but decreased for soybeans between 1952-72 and 1974-95. These findings suggest that unavoidable social loss has decreased in the corn market, but has increased in the soybean market. Last, since 1973, the spring quotes of the corn and soybean harvest futures are significantly less variable from year-to-year than the eventual harvest prices. This finding suggests that hedging expected corn and soybean production at planting can significantly reduce year-to-year variability in price received at harvest.

 
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An Analysis of the Performance of the Diammonium Phosphate Futures Contract
Keith Bollman, Sarahelen Thompson, and Philip Garcia
Year: 1996
 

Abstract

This paper investigates the price relationships between diammonium phosphate cash and futures prices to evaluate pricing and risk management in the fertilizer industry, the potential demand for hedging within the industry, and the price linkages through the market system. The results indicate poor market integration among the DAP cash and futures markets. The results also show the current DAP futures contract behaves as a forward contract with a high rate of delivery causing the contract to be a poor hedging tool.

 
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Evaluating the Hedging Potential of the Lean Hog Futures Contract
Mark W. Ditsch and Raymond M. Leuthold
Year: 1996
 

Abstract

The lean hog futures contract is replacing the live hog futures contract at the Chicago Mercantile Exchange beginning with the February 1997 contract. The lean hog futures will be cash settled based on a broad-based lean hog price index, eliminating terminal markets from the price discovery process. Using this index over a twenty-month period as a proxy for the lean hog futures price, this paper compares the hedging effectiveness of the live hog futures contract to the hedging potential of the lean hog futures contract for cash live hogs as well as four cash meat cuts. Frozen pork bellies futures are also examined for the cash meats. Both long-term and short-term hedges are simulated, using the minimum-variance approach, which utilizes only unconditional information, and the Myers-Thompson approach that incorporates conditional information. The results show that the lean hog futures should perform better than either the live hog or the frozen pork bellies futures as a hedging instrument for Omaha cash hogs and cash loins. The strongest evidence of this is for the short-term hedging of cash hogs. For the other three meats, no futures contract demonstrated a clear hedging advantage.

 
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