NCCC-134
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The Value of Deregulating Over-The-Counter Options
Darren L. Frechette and Jason A. Novak
Year: 2001
 

Abstract

Hedgers located far from organized commodity exchanges suffer the mismatch between their local prices and exchange prices. Futures and options traded on the exchange may still be valuable to distant hedgers but only to the extent that basis risk is small. Forward contracting allows hedgers to manage risk using a local delivery price, but the CFTC has long banned the sale off-exchange options, limiting the opportunities available to hedgers. Recently, Agricultural Trade Options (ATOs) have been introduced as over-the-counter option products designed specifically for hedgers. To date, ATOs have found little interest from potential sellers, but the potential demand for these options may be substantial. This paper describes and quantifies the demand for corn ATOs by dairy farms in Southeastern Pennsylvania and estimates the value these farms might place on options contracts offered locally.

 
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USDA Production Forecasts for Pork, Beef, and Broilers: A Further Evaluation
Dwight R. Sanders and Mark R. Manfredo
Year: 2001
 

Abstract

This paper examines USDA one-step ahead forecasts of quarterly beef, pork, and poultry production. The forecasts are evaluated based on traditional criteria for optimality—efficiency and unbiasedness—as well as their performance versus an univariate time series model. The results suggest that the USDA forecasts are unbiased; however, they are generally not efficient. That is, they do not fully incorporate the information contained in past forecasts. Moreover, the USDA predictions do not encompass all the information contained in forecasts generated by simple time series models.

 
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Underpinnings for Prospective, Net Revenue Forecasting in Hog Finishing: Characterizing the Joint Distribution of Corn, Soybean Meal and Lean Hogs Time Series
Renyuan Shao and Brian Roe
Year: 2001
 

Abstract

This research focuses on developing a biannual net revenue forecasting model for hog producers based on Monte Carlo simulation of the joint distribution of hog, corn and soybean meal price series. The relative forecasting power of historical volatility, implied volatility and GARCH-based volatility is examined. Consistent with recent research, the performance of these three methods is both commodity and horizon specific, which means there is no single best predictor. However, implied volatility often performs well. Thus, implied volatility is used to forecast variance. Historical covariance is introduced to capture the co-movement of the three price series. Our forecasting model performs well out of sample; most of the realized net revenues fall in 95 percent prediction interval. Based on this forecasting model and the assumption of a utility function, we compare our prospective evaluation with retrospective evaluation of risk management strategies. Though prospective evaluation is not significantly superior to retrospective evaluation for this particular dataset, it is useful because all the market information has been incorporated in this model and because it did protect producers from adverse price movements.

 
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Income Enhancing and Risk Management Properties of Marketing Practices
Hikaru Hanawa Peterson and William G. Tomek
Year: 2001
 

Abstract

A rational expectations storage model is used to simulate monthly corn prices, which are used to evaluate marketing strategies to manage price risk. The data are generated and analyzed in two formats: for long-run outcomes over 10,000 “years” of monthly prices and for 10,000 cases of 40-year “lifetimes.” Three categories of strategies are analyzed: frequency of post-harvest cash sales, unconditional hedges, and conditional hedges. The comparisons are based on the simulated probability distributions of net returns. One conclusion is that diversifying cash sales, without hedging, is not an efficient means of risk management. Unhedged storage does not reduce risk and, on average, reduces returns. The analysis of the 40-year lifetimes demonstrates, however, that rational decision-makers can face “lucky” and “unlucky” time periods. Thus, although the long-run analysis suggests that routine hedging reduces the variance (and the mean) of returns compared to the base case of selling in the spot market at harvest, the variance of returns (and their means) from both strategies will vary from lifetime to lifetime. Efficient strategies for producers with increasing utility functions vary from lifetime to lifetime, suggesting that efficient strategies likely vary from year-to-year. Nonetheless, strategies that take advantage of locking in returns to storage when relative prices are favorable are efficient in the second-degree sense and appear robust across different lifetimes. We also illustrate that conclusions are influenced by the measure of risk used. Perhaps the major conclusion is, however, that risk-management analysis is complex and potentially filled with pitfalls.

 
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Forecasting and Hedging Crop Input Prices
Kevin C. Dhuyvetter, Martin Albright, and Joseph L. Parcell
Year: 2001
 

Abstract

Agricultural producers and input suppliers have to make management decisions based on forecasts all the time, however, most available forecasts are for outputs (e.g., grain and livestock). Research has shown that one of the most important determinants of relative profitability for producers is being a low-cost operator. Research has also shown that relatively simple forecasting models are often superior to more complex models. Thus, producers may benefit from having simple models for forecasting crop input costs. The objective of this research was to estimate models based on futures markets that could be used to forecast input prices, specifically, diesel fuel, natural gas, and anhydrous ammonia. Results suggest that diesel prices forecasted using the crude oil or heating oil futures market are reasonably accurate and that this approach may be superior to using an historical average. While diesel prices could be effectively cross hedged with the crude oil or heating oil futures market, the contracts represent relatively large quantities which may exceed individual producer’s needs so cross hedging may only be practical for input suppliers. Likewise, producers using natural gas for irrigation can use the natural gas futures market to predict what their local cash prices will be. Anhydrous ammonia prices can be predicted using natural gas prices, however, because of a major structural change that occurred in the nitrogen fertilizer industry during the mid nineties these price forecasts are less reliable.

 
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Emerging Issues and Challenges in Applied Commodity Price Analysis
Marvin L. Hayenga
Year: 2001
 

Abstract

This organization (NCR-134) began 20 years ago to serve as a meeting ground for applied commodity price analysts in academic, business and government positions. The primary objective was to foster interaction, and discuss recent applied research and extension applications, and emerging related issues that might warrant attention. The interchange of ideas has continued for 20 years, and your participation over the years has made it the success that it is today. My focus today will not be on history, however. Rather, it is a set of observations about how I see the world in which we operate, and some challenges and opportunities that deserve more thought and attention as we serve our various customers for our professional expertise. My goal is to provide one useful idea to each of you.

 
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Factors Affecting Hedging Decisions Using Evidence from the Cotton Industry
Olga Isengildina and M. Darren Hudson
Year: 2001
 

Abstract

Few farmers utilize futures and options markets to price their crops despite significant educational efforts. This study seeks to analyze producer hedging behavior within the framework of the overall marketing behavior. Producer marketing behavior is modeled as a simultaneous choice between cash sales, cooperative marketing and forward contracts, and hedging. A multinomial logit model is used for empirical estimation using data from a survey administered to a sample of cotton producers from across the U.S. The most important factors that explain the use of forward pricing by cotton producers are producer preferences, farm size, use of crop insurance, risk aversion, income from government payments and off-farm income. Risk aversion, off-farm income, crop insurance and some producer perceptions are important in the choice of the form of forward pricing (direct hedging vs. cooperative marketing and forward contracts).

 
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Will Mandatory Price Reporting Improve Pricing and Production Efficiency in an Experimental Market for Fed Cattle?
Chris T. Bastian, Stephen R. Koontz, and Dale J. Menkhaus
Year: 2001
 

Abstract

Mandatory price reporting legislation will make available to the public on a weekly basis information on terms of trade for forward contracts. The new information will provide marketing intentions details that were previously unavailable to agents in the fed cattle market. An experiment was designed to assess the potential impacts of this new information on price discovery and production efficiency. Results suggest that the proposed new information will reduce price level, reduce price dispersion, and improve production efficiency. Prices may be reduced as information risks are reduced for both buyers and sellers in the fed cattle market. This result may not be popular among sellers in the market.

 
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Why Don’t Country Elevators Pay Less for Low Quality Wheat? Information, Producer Preferences and Prospect Theory
Brian D. Adam and Seung Jee Hong
Year: 2001
 

Abstract

Previous research found that country elevators that are the first in their area to grade wheat and pay quality-adjusted prices would receive above-normal profits at the expense of their competitors. Because of spatial monopsony, these early-adopting elevators would pass on to producers only 70% of the quality-based price differentials received from next-in-line buyers. If competing elevators also adopted these practices, profits for all elevators would return to near normal, and elevators would pass on to producers nearly all price differentials received from next-in-line buyers. However, that research could not explain why more elevators were not becoming “early adopters” by paying quality-adjusted prices. More recent research found that producers’ risk aversion and lack of information about the quality of their wheat could explain more of the failure of country elevators to pass on premiums and discounts. If producers are risk averse, an elevator that imposes discounts for lower quality wheat, even while paying a higher price for high quality wheat, risks losing business if producers believe that a competing elevator may be more likely to pay them a higher price net of discounts. However, even more important is the level of information producers have about the quality of their wheat before selling it to an elevator. Still, these explanations account for only part of elevators’ apparent reluctance to pay quality-adjusted prices. Since inconsistencies have been observed between expected utility and individuals’ behavior, this research considers the case where producers’ preferences can be more appropriately modeled by prospect theory, and whether such preferences can explain more of elevators’ reluctance to pay quality-adjusted prices. A simulation model is used to measure the effects of risk-averse producers (in both expected utility and prospect theory frameworks) and limited quality information on profits that can be earned by an elevator that pays quality-adjusted prices. Results indicate that prospect theory helps to explain part, but not all, of the reluctance to pay quality-adjusted prices.

 
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Unobserved Heterogeneity: Evidence and Implications for SMEs’ Hedging Behavior
Joost M.E. Pennings and Philip Garcia
Year: 2001
 

Abstract

Financial research indicates that several firm characteristics are related to the use of derivatives. Less attention has been paid to the role of the characteristics of managers, which are particularly important when studying derivative usage of small and medium sized enterprises (SMEs). In this paper we focus on the influence of manager’s level of education, the manager’s decision-making unit, and the fundamental determinants of risk management — managerial risk attitude and managerial risk perception — on SMEs’ commodity derivative usage. In empirical studies to date, the heterogeneity of derivative users has been neglected. We propose a generalized mixture regression model that estimates the relationship between commodity derivative usage and a set of explanatory variables across segments of an industry. Accounting for unobserved heterogeneity reveals that segments of the industry have different determinants of derivative use. Moreover, the heterogeneity at the segment level appears to mask significant effects at the aggregate level, most notably the effects of risk attitude and risk perception.

 
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Model Selection Criteria Using Likelihood Functions and Out-of-Sample Performance
Bailey Norwood, Peyton Ferrier, and Jayson Lusk
Year: 2001
 

Abstract

Model selection is often conducted by ranking models by their out-of-sample forecast error. Such criteria only incorporate information about the expected value, whereas models usually describe the entire probability distribution. Hence, researchers may desire a criteria evaluating the performance of the entire probability distribution. Such a method is proposed and is found to increase the likelihood of selecting the true model relative to conventional model ranking techniques.

 
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Implications of Behavioral Finance for Farmer Marketing Strategy Recommendation
B. Wade Brorsen and Kim B. Anderson
Year: 2001
 

Abstract

Behavioral finance is a relatively new field of inquiry that may help better understand farmer marketing. The theory argues that people tend to make certain psychological biases that cause them to not be fully rational in an economic sense. For example, people tend to be about twice as upset about a loss as they would be happy about a gain of the same size. The theory can help explain why producers would pay a marketing consultant even when markets are efficient. Extension programs need to consider the psychology of marketing. The theory suggests that decisions need to be framed in terms of their effect on the whole farm operation and in terms of profits over a series of years.

 
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Local Polynomial Kernel Forecasts and Management of Price Risks using Futures Markets
MinKyoung Kim, Raymond M. Leuthold and Philip Garcia
Year: 2001
 

Abstract

This study contributes to understanding price risk management through hedging strategies in a forecasting context. A relatively new forecasting method, nonparametric local polynomial kernel (LPK), is used and applied to the hog sector. The selective multiproduct hedge based on the LPK price and hedge ratio forecasts is, in general, found to be better than continuous hedge and alternative forecasting procedures in terms of reduction of variance of unhedged return. The findings indicate that combining hedging with forecasts, especially when using the LPK technique, can potentially improve price risk management.

 
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Estimating Actual Bid-Ask Spreads in Commodity Futures Markets
Henry L. Bryant and Michael S. Haigh
Year: 2001
 

Abstract

Various bid-ask spread estimators are applied to transaction data from LIFFE cocoa and coffee futures markets, and the resulting estimates are compared to observed actual bid-ask spreads. Results suggest that actual bid-ask spreads, which are not reported by most open-outcry futures markets, can be reasonably estimated using readily available transaction data. This is especially important since recent research seems to indicate that efforts to estimate effective spreads using data commonly available from futures markets have not been successful. Thus estimates of actual spreads can give market participants and researchers some idea of potential transaction costs. Accurate estimates of bid-ask spreads will also be needed to assess the relative efficiency of electronic versus open-outcry trading. Results indicate that estimators using averages of absolute price changes perform significantly better at estimating actual bid-ask spreads in futures markets than estimators using the covariance of successive price changes.

 
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The Role of the Bid-Ask Spread in a Dynamic–Time-Varying Optimal Hedging Model
Michael S. Haigh
Year: 2001
 

Abstract

This paper presents a manageable and effective way of nesting two popular, yet distinct approaches to obtain optimal hedging ratios – time-series econometrics (GARCH) and dynamic programming (DP). The nested DP-GARCH model is then compared to a DP-GARCH model that accounts for variability in the bid-ask spread often unobserved (and hence ignored) in most studies. Results from an empirical application using data from an importantly traded commodity – sugar – suggest that a DP-GARCH model that incorporates the bid-ask spread still outperforms more traditional models. Moreover, the hedging ratios are far less volatile, and statistically different, than those recommended by the traditional GARCH methods that ignore the spread.

 
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Modeling Soybean Prices in a Changing Policy Environment
Barry K. Goodwin, Randy Schnepf, and Erik Dohlman
Year: 2001
 

Abstract

The oilseed products complex is an important component of the U.S. agricultural sector. In 2000, almost 75 million acres were planted to soybeans, representing over 29 percent of total planted acreage, making soybeans second only to corn in terms of acreage (ERS/USDA, 2000). Soybean acreage has increased steadily since 1990, when only 58 million acres were planted. From a historical perspective, soybeans are rather unique in that they were not eligible for target-price deficiency payments nor were they subject to the explicit acreage restrictions of other program crops. However, the acreage-idling and base-acreage requirements, as well as government stock-holding behavior, of other program crops has indirectly affected soybean acreage decisions in the past. Soybeans have been eligible for government price support loans for the past sixty years. In recent years, soybeans have benefited from a high loan rate relative to corn. This, coupled with eligibility for government marketing loan gains and loan deficiency payments, has stimulated production of soybeans.

 
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Modeling Farmers’ Use of Market Advisory Services
Joost M.E. Pennings, Scott H. Irwin, and Darrel L. Good
Year: 2001
 

Abstract

In an effort to improve marketing of their products, many farmers use market advisory services (MAS). To date, there is only fragmented anecdotal information about how farmers actually use the recommendations of market advisory services in their marketing plans, and how they choose among these services. Based on the literature on consulting services usage, a conceptual framework is developed in which perceived performance of the MAS regarding realized crop price and risk reduction, and the match between the MAS and the farmer’s marketing philosophy drive MAS usage. To account for possible heterogeneity among farmers regarding to the use of MAS, we introduce a mixture-modeling framework that is able to identify unobserved heterogeneity. With this modeling framework we are able to simultaneously investigate the relationship between market advisory usage and the key components of our conceptual model for each unobservable segment in the population. A large scale interview of US farmers that contained several experiments revealed that farmers’ use of MAS not only depends on the outcome of their services (price and risk reduction performance) but also on the way these services are delivered, i.e., the match of marketing philosophy between farmers and MAS. The influence of the factors in our conceptual model did not influenced farmers MAS usage equally across the whole sample. Using the generalized mixture model framework we found 5 segments that differed regarding the influence that these factors have on farmers MAS usage. The heterogeneity of the farmers appeared to be unobserved, in that it could not be traced back to observable variables such as age and region. It is the decision-making process itself, as reflected in our conceptual model, that caused the heterogeneity.

 
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Hypothesis Testing Using Numerous Approximating Functional Forms
Bailey Norwood, Jayson Lusk, and Peyton Ferrier
Year: 2001
 

Abstract

While the combination of several or more models is often found to improve forecasts (Brandt and Bessler, Min and Zellner, Norwood and Schroeder), hypothesis tests are typically conducted using a single model approach 1 . Hypothesis tests and forecasts have similar goals; they seek to define a range over which a parameter should lie within a degree of confidence. If it is true that, on average, composite forecasts are more accurate than a single model’s forecast, it might also be true that hypothesis tests using information from numerous models are, on average, more accurate in the sense of lower Type I and Type II errors than hypothesis tests using a single model.

 
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Consumer Panelist Behavior in Experimental Auctions: What Do We Learn from Their Bids?
Wendy J. Umberger and Dillon M. Feuz
Year: 2001
 

Abstract

Experimental economics procedures such as laboratory experimental auctions are increasingly being used to measure consumers’ willingness-to-pay. A sealed-bid, fourth-price Vickrey-style auction was used to measure consumers’ willingness-to-pay for flavor in beef steaks. Two hundred and forty-eight consumers from Chicago and San Francisco participated in the experimental auctions. The data gathered from these experimental auctions was then used to examine individual demand or utility in an experimental, uniform-price auction; and to analyze market demand and market price in an experimental auction when supply is fixed but demand varies. The results indicated that certain demographic variables may increase the probability that a participant wins or loses an experimental auction. The market price was found to be a function of the number of participants in a panel, as well as consumers’ tastes and preferences. Changes in the market price of the auctions in the study appear to be more a function of the same factors that influence demand in the marketplace, rather than a wealth effect. Consumers in this research did appear to be expressing their true value for the auction product and the auction provided a valuable measure of consumers’ WTP for flavor.

 
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Market Inversion in Commodity Futures Prices
Byung-Sam Yoon and B. Wade Brorsen
Year: 2001
 

Abstract

As opposed to a normal market, an inverted market has a negative price of storage or spread. Market inversions in nearby spreads rarely occur during early months of the crop year since stocks are usually abundant after harvest. However, market inversions frequently occur when the spreads are observed across crop years near the end of the crop year. The regressions of spreads on the logarithm of U.S. quarterly stocks show that there exists a positive relationship between the spread and the level of stocks, and further implies that when stocks are scarce, markets will be inverted. Simulations are conducted to determine whether a market inversion is a signal to sell the stocks. The results of the paired-difference tests reveal that as the crop cycle advances towards the end of the crop year, market inversions clearly reflect the market’s signal to release stocks in anticipation of new crop supplies. The regressions of actual returns to storage on predicted returns to storage clearly show that a market inversion is a signal to sell. The results support the behavioral finance hypothesis that producers are choosing to hold excess stocks because of some type of biased expectations.

 
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Evaluation Of Hedging in the Presence of Crop Insurance and Government Loan Programs
Manuel Zuniga, Keith H. Coble, and Richard Heifner
Year: 2001
 

Abstract

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.

 
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Crop Insurance Valuation under Alternative Yield Distributions
Fabio C. Zanini, Bruce J. Sherrick, Gary D. Schnitkey, and Scott H. Irwin
Year: 2001
 

Abstract

Considerable disagreement exists about the most appropriate characterization of farm-level yield distributions. Yet, the economic importance of alternate yield distribution specifications on insurance valuation, product designs and farm-level risk management has not been investigated or documented. The results of this study demonstrate that large differences in expected payments from popular crop insurance products can arise solely from the parameterization chosen to represent yields. The results suggest that the frequently unexamined yield distribution specification may lead to incorrect conclusions in important areas of insurance and risk management research such as policy rating, and assessment of expected payments from policies.

 
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Market-making Behavior in Futures Markets
Holly Liu, Jeffrey Williams, and Oscar Jorda
Year: 2001
 

Abstract

This paper examines voluntary market-making behavior, namely scalping, in futures markets. Specifically, this paper studies what factors determine scalpers' entry and exit, and how scalping affects market liquidity and price volatility. The data used for the analysis are time-stamped electronic transaction data marked with traders' identities from the Dalian Futures Exchanges in China. The contributions of this paper are: (1) to give detailed analysis of scalping behavior and its impact on market liquidity; (2) to develop new econometric tools for analyzing time-series count data; (3) to propose a new measure of liquidity. Keywords: Liquidity, Market-Making, Futures Markets, Scalpers, Autoregressive Conditional Intensity (ACI), Volatility.

 
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Response to an Asymmetric Demand for Attributes: An Application to the Market for Genetically Modified Crops
Sergio Lence and Dermot Hayes
Year: 2001
 

Abstract

A framework is developed for examining the price and welfare effects of the introduction of genetically modified (GM) crops. In the short run, non-GM grain generally becomes another niche product. However, more profound market effects are observed under some reasonable parameterizations. In the long run, consumer and producer welfare are usually greater after the introduction of GM technology. However, in all instances some consumers and some producers lose. When identity preservation is expensive and cost savings are relatively small, both producer and consumer welfare are lower after introducing GM technology. Interestingly, this outcome is obtained even though all agents are individually rational.

 
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The Value of USDA Outlook Information: An Investigation Using Event Study Analysis
Scott H. Irwin, Darrel L. Good, and Jennifer K. Gomez
Year: 2001
 

Abstract

The economic value of public situation and outlook information has long been a subject of debate. The purpose of this paper is to investigate the economic value of USDA WASDE reports in corn and soybean markets. The investigation is based on event study analysis, with the "events" consisting of the release of all monthly USDA WASDE reports for corn and soybeans from 1985 through 1998. The WASDE reports during the sample period are divided into two groups: one that represents “pure” outlook information and one that represents a “mix” of situation and outlook information. The statistical tests can be placed into two categories: mean price reaction and volatility reaction. Overall, the results suggest that USDA outlook information has a significant impact in corn and soybean markets. The most notable impact is found in options markets, where implied volatility consistently declines after the release of WASDE reports. For the group of monthly reports containing only outlook information, implied volatility for both corn and soybeans was lower on the report day than on the previous day about 60 percent of the time. The difference in mean implied volatility on the day of the report and on the previous day for both corn and soybeans was significantly different from zero. The average magnitude of the drop was between about two- and three-tenths of a percentage point (of annualized implied volatility), which would appear to be an economically non-trivial decrease. Hence, it can be concluded that USDA outlook information reduces the uncertainty of market participants’ expected distribution of future prices. This reduction in market uncertainty is unambiguously welfare-enhancing.

 
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