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Calendar vs. Weeks to Expiration Livestock Basis Forecasts: Which Is Better?
Glynn T. Tonsor, James R. Mintert, and Kevin C. Dhuyvetter
Year: 2003
 

Abstract

The ability to accurately forcast basis is crucial to risk management strategies employed by many agribusiness firms. Previous research has examined how to effectively use basis forecasts and what factors affect basis, but literature focusing on forecasting basis is sparse. This research evaluates the impact of adopting a time-to-expiration approach, as compared to the more common calendar approach, when forecasting feeder cattle, live cattle, and hog basis. Furthermore, the optimal number of past year's basis levels to include in making basis predictions is evaluated in an out-of-sample framework. Absolute basis forecasts errors are generated for all three commodities and evaluated to determine the signifcance of the two issues mentioned above. Results indicate that basis forecasters should consider using three-year historical averages for feeder cattle and four-year historical averages for live cattle and lean hogs when making basis forecasts. Furthermore, the use of a time-to-expiration method of calculating historical average basis results in very little improvement in basis prediction accuracy compared to the calendar approach. Keywords: livestock prices, basis, hedging, basis forecasts

 
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Using Private Risk Management Instruments to Manage Counter-Cyclical Payment Risks Under the New Farm Bill
John D. Anderson, Keith H. Coble, and J. Corey Miller
Year: 2003
 

Abstract

This research evaluates whether or not hedging strategies using call options on the New York Board of Trade cotton futures can be effectively used to protect the new counter-cyclical payment on cotton. Results indicate that some level of counter-cyclical payment hedging is optimal for risk averse decision makers. Optimal hedge ratios depend on planting time expectations of the marketing year average price as well as on what crop, if any, has been planted on the base acres receiving the counter-cyclical payment.

 
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The Term Structure of Implied Forward Volatility: Recovery and Informational Content in the Corn Options Market
Thorsten M. Egelkraut, Philip Garcia, and Bruce J. Sherrick
Year: 2003
 

Abstract

Options with different maturities can be used to generate volatility estimates for non-overlapping future time intervals. This paper develops the term structure of volatility implied by corn futures options, and evaluates the informational content of the implied forward volatility as a predictor of subsequent realized volatility. Using data from 1987-2001 and employing a flexible method to obtain the implied forward volatilities, two types of information are examined: 1) the market's estimate of future realized volatility for the nearby interval of the term structure and, 2) the market's expectation of the direction and magnitude of change of future realized volatility over time. In contrast to previous research, the results indicate that the implied forward volatilities anticipate the realized volatilities provide unbiased forecasts and capture a larger portion of the systematic variability in the realized volatilities than forecasts based on historical volatilities. Using information on the direction and magnitude of change in volatility over time, we find that the early-year options forecast volatility about as well as the three-year moving average and better than the naive forecast, while later-year options and alternative forecasts are less able to predict the direction and magnitude of changing volatility. During this later-year period, the implied forward volatilities tend to over-predict the magnitude of actual volatility. Overall, we find that the term structure of volatility implied by corn futures options contains information on future realized volatility. Keywords: corn options, implied forward volatility, informational content, term structure

 
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Market Integration: Case Studies of Structural Change
Jason R.V. Franken and Joe L. Parcell
Year: 2003
 

Abstract

The grain/oilseed industry is undergoing considerable structural change in the form of mergers and the addition of new processing facilities to add value beyond commodity grade. The rapid structural changes in this industry call into question the relevance of previous research conducted in these areas. Focusing on two structural change events in northeast Missouri as case studies provides an incisive glimpse at the larger impact of structural change on the grain/oilseed industry. This study addresses the merger of Archer Daniels Midland and Quincy Grain, and the opening of a producer-owned ethanol plant in northeast Missouri to determine if these structural change events altered pricing patterns and linkages in Missouri grain/oilseed markets, and assess the need for re-specification of conventional economic models for price analysis in cases of potential structural change. This research utilizes a three-tier statistical analysis of cointegration tests, Flexible Least Squares analysis, and impulse response functions derived from Vector Autoregressive modeling to investigate the Law of One Price and price relationships among four Missouri grain/oilseed markets. The results are consistent with the Law of One Price, supporting the ideology that markets work, and implying that localized structural change may not significantly affect research shelf-life. Keywords: Ethanol, Consolidation, Structural Change

 
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Managing Dairy Profit Risk Using Weather Derivatives
Gang Chen, Matthew C. Roberts, and Cameron Thraen
Year: 2003
 

Abstract

Weather conditions are the primary dairy production risk. Hot and humid weather induces heat stress, which reduces both the quantity and quality of milk production. Traditional heat abatement technologies control the environment through ventilation, misting or evaporative cooling. Usually, they can increase the producers' expected profit, but cannot cover all the profit losses from heat stress. Weather derivatives could reduce weather-induced profit risk and thus act as a substitute for traditional abatement technologies in the aspect of risk management. We test the risk management value of weather derivatives in a utility maximization framework. The result is that weather derivatives offer an opportunity to improve the efficient portfolio frontier, and simultaneously using weather derivatives and abatement equipment is more favorable than using each of them alone.

 
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An ARCH Analysis of The Hedging Performance of Imminently Maturing Future contracts
Roger A. Dahlgran
Year: 2003
 

Abstract

Hedge ratio estimation studies avoid estimating hedge ratios for imminently maturing futures contracts because of the maturity effect whereby futures price volatility increases as price uncertainty is resolved at contract expiration. This study first points out that a futures-price volatility increase is neither necessary nor sufficient for reduced hedging effectiveness because hedging effectiveness depends on the cash-futures price correlation. To analyze the hedging performance of imminently maturing futures contracts risk is defined as the conditional variance of profit outcomes. The conditional mean is modeled as Brownian motion. This model was fit to cash and futures price data for corn, cotton, feeder cattle, soybeans, soybean oil, and soybean meal using daily observations from January 1990 through mid-March 2002. Test results indicate that daily futures prices for these commodities follow a random walk while spot prices are predictable. Therefore, zero (for futures prices? and the predicted value (for spot prices) were used as the conditional means in estimating the conditional variances for futures and spot prices. Volatility is analyzed as an ARCH process with a mean that follows a quadratic function of days to maturity. It was found that the quadratic function was significant for all futures contracts with the volatility minimum occurring between 131 and 259 days before contract maturity. The ARCH effects were generally not significant for futures prices while spot price volatility displayed significant ARCH effects. The maturity effects in the futures markets has a dominant influence on the spot-futures correlation so that the effectiveness of hedging tends to decrease as the futures price volatility begins to increase. The effectiveness decline occurs far sooner than the contract selection rules imply. Keywords: maturity effect, hedging effectiveness, risk management

 
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USDA Interval Forecasts of Corn and Soybean Prices: Overconfidence or Rational Inaccuracy?
Olga Isengildina, Scott H. Irwin, and Darrel L. Good
Year: 2003
 

Abstract

The USDA WASDE (World Agricultural Supply and Demand Estimates) price forecasts are published in the form of an interval, but typically analyzed as point estimates. Thus, all information about uncertainty imbedded in the forecast is ignored. The purpose of this paper is to evaluate the accuracy of WASDE price forecasts using methodology suitable for testing judgmental interval forecasts. Empirical analysis includes traditional statistical tests as well as an alternative behavioral evaluation (accuracy-informativeness tradeoff model). The results of the traditional analysis indicate overconfidence of WASDE price interval forecasts, while the results of the behavioral approach suggest rational inaccuracy. Keywords: interval forecasts, overconfidence, rational inaccuracy, accuracy-informativeness tradeoff, WASDE

 
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The Feasibility of a Boxed Beef Futures Contract: Hedging Wholesale Beef Cuts
Fabio Mattos, Philip Garcia, Raymond Leuthold, and Tony Hahn
Year: 2003
 

Abstract

The purpose of this paper is to investigate the feasibility of a new futures contract for hedging wholesale transactions in the beef industry based on the USDA boxed beef cutout index (BBCO). The results suggest the live cattle futures contract is not an adequate tool to manage the price risk of wholesale meat transactions in the beef industry. However, a futures contract based on the BBCO index might provide considerably more opportunities for the hedging of wholesale meat cut prices. A pattern of improved hedging effectiveness at more distant horizons also appears to emerge for the individual cuts of meat using the conditional hedge procedures. These results may be of particular interest to members of the meat industry with longer planning horizons, and more diversified transactions. Keywords: hedge ratio, hedging effectiveness, boxed-beef cutout, wholesale beef prices

 
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Pricing Weather Derivatives for Agricultural Risk Management
Timothy J. Richards,* Mark R. Manfredo, and Dwight R. Sanders
Year: 2003
 

Abstract

Existing derivative pricing methods cannot be used to price weather derivatives due to the absence of a hedgeable commodity underlying weather risk and the complexity of weather processes. This study develops a pricing model that considers weather derivatives to be the same as any other financial asset. In this way, the price of a weather derivative is an equilibrium price consistent with both the potential payout at expiry and the market price of risk. We apply this model to the pricing of weather derivatives in the Central Valley of California and find significant differences in prices obtained under alternative weather process assumptions. Keywords: derivative, Monte Carlo, pricing, risk weather

 
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Information Cascades with Financial Market Professionals: An Experimental Study
Jonathan E. Alevy, Michael S. Haigh, and John A. List
Year: 2003
 

Abstract

In settings where there is imperfect information about an underlying state of nature, but where inferences are made sequentially and are publicly observable, information cascades can lead to rational herding. Cascade phenomena may be seen in a variety of areas including technology adoption, financial market behavior, as well as in social processes such as mate selection or fads and fashions. Theories of rational herding have found a natural testing ground in experimental environments since the character of private and public information can be readily controlled. In previous experimental studies, behavior consistent with Bayesian benchmarks has been observed in simple contexts, but there are substantial reductions in experimental environments that introduce relevant complications such as costly information. In this paper we make use of a unique subject pool, that of financial market professionals from the floor of the Chicago Board of Trade, to investigate the role of market experience on herding behavior. We find that market professionals behave differently than a control group of college student subjects. In particular the Bayesian behavior of those with market experience does not differ significantly across the gain and loss domains. Cascade formation also differs across the subject pools with market professionals entering fewer reverse cascades.

 
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Technical Analysis in Commodity Markets: Risk, Returns, and Value
Matthew C. Roberts
Year: 2003
 

Abstract

Although there is little academic research that supports the usefulness of technical analysis, its use remains widespread in commodity markets. Much prior research into technical analysis suffered from data-snooping biases. Using genetic programming, ex ante optimal technical trading strategies are identified. Because they are mechanically generated from simple arithmetic operators, they are free of the data-snooping bias common in technical analysis research. These rules are clearly capable of forecasting periods of high and low volatility, but rules generated for corn and soybeans cannot consistently generate profits in the presence of transactions costs. Rules generated for wheat futures produce profits that are weakly significant, both statistically and economically. Keywords: Technical Analysis, Genetic Algorithms, Commodity Markets, Futures Markets

 
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Spatial Competition and Pricing in the Agricultural Chemical Industry: Empirical Evidence from Georgia
R. Lee Hall, Jeffrey H. Dorfman, and Lewell F. Gunter
Year: 2003
 

Abstract

Three models of spatial competition are tested on retail price data for the agricultural chemical industry. Three empirical tests find no evidence of any spatial competition using data from sixty-five retailers and twelve different chemicals. Demand and supply-side variables have statistically significant, but economically trivial impacts on retail chemical prices. These results point to a virtually complete control of retail prices by the chemical manufacturers, likely through the rebate program they offer retailers. The oligopoly structure of the chemical manufacturing industry makes such control possible. The results suggest that consolidation of retailers or distributors will not have anti-competitive effects since price competition is essentially absent from this market already. Keywords: agricultural chemicals, market power, spatial competition

 
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Comparing the Performances of the Partial Equilibrium and Time-Series Approaches to Hedging
Henry L. Bryant and Michael S. Haigh
Year: 2003
 

Abstract

This research compares partial equilibrium and statistical time-series approaches to hedging. The finance literature stresses the former approach, while the applied economics literature has focused on the latter. We compare the out-of-sample hedging effectiveness of the two approaches when hedging commodity price risk using a simple derivative with a linear payoff function (a futures contract). For various methods of parameter estimation and inference, we find that the partial equilibrium models cannot out-perform the time series model. The partial equilibrium models unpalatable assumptions of deterministically evolving futures volatility seems to impede their hedging effectiveness, even when potentially foresighted option-implied volatility term structures are employed.

 
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Market Dynamics Associated with a Beefpacking Plant Closing and a Porkpacking Plant Opening
Jonathan T. Hornung and Clement E. Ward
Year: 2003
 

Abstract

Previous research has estimated price effects of meat packing plant closings and openings. However, none have been done for plants opening or closing during the last 20 years ago when concentration in meatpacking increased rapidly. Plant openings and closings affect industry slaughtering capacity. Many analysts contribute the lack of processing capacity to handle the large supply of hogs in 1998 a major factor why spot market hog prices plummeted to unprecedented lows. Just eight months after the capacity constraint in slaughter hogs, Maple Leaf Foods opened a hog processing plant in Brandon, Manitoba. A second but opposite event occurred in the beef industry in an area of concentrated cattle feeding and meatpacking. On Christmas day, 2000, the ConAgra fed cattle processing plant was damaged by fire in Garden City, Kansas. The objective of this research is to determine the market effects of a plant opening in the porkpacking industry and a plant closing in the beef packing industry. Regression models were estimated to compare reported weekly average prices in the market where the plant opened or closed with comparable prices for benchmark markets before and after the plant opening or closing. Regression models followed previous research but explained relatively little of the variation in price ratios between the affected market area and comparison markets. Small price effects were found in some cases but with little consistency. Keywords: Meatpacking, Fed cattle, Slaughter hogs, Marketing, Prices

 
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Futures Market Depth: Revealed vs. Perceived Price Order Imbalances
Joost M.E. Pennings, Philip Garcia, and Julia W. Marsh
Year: 2003
 

Abstract

In this paper we study futures market depth by examining the price path due to order imbalances thereby allowing us to directly gain insight in the execution costs due to a lack of market depth We propose a two dimensional market depth measure in which the price path due to order imbalances is described by an S-shape function. The proposed market depth measure is applied to transaction specific futures data from Euronext. Subsequently, we examine CBOT traders' perceptions about the price path due to order imbalances and examine the characteristics that are associated with a particular perception. The proposed market depth measure gives guidelines for improving market depth, and can be used to compare competitive futures contracts. It appears that the actual price path due to order imbalances does not match the perceived price path. Traders have various perceptions about the price path due to order imbalances. Dominant perceptions were, S-shape, linear, exponential or zigzag price paths. The differences in traders' perceptions can be traced back to different traders' characteristics among others type of primary futures contract traded, importance of information sources and trading strategy (herd vs. non-herd behavior). The observed disconnect between perceptions and revealed price path due to order imbalances have great implications for market participants who try to minimize execution costs and for the futures exchange management that tries to increase the market depth.

 
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Keep up the Good Work? An Evaluation of the USDA’s Livestock Price Forecasts
Dwight R. Sanders and Mark R. Manfredo
Year: 2003
 

Abstract

One step-ahead forecasts of quarterly live cattle, live hog, and broiler prices are evaluated under two general approaches: accuracy-based measures and the ability to categorize price movements directionally or within a forecasted range. Results suggest USDA price forecasts are not optimal. Broiler price forecasts are biased, and all the forecast series tend to repeat errors. While the USDA forecasts are more accurate that those of a univariate AR(4) time series model, the evidence suggests that live cattle forecasts could be improved with a composite forecast. However, the USDA correctly identifies the direction of price change in at least 70% of its forecasts. Prices fall within the USDA's forecasted range 48% of the time for broilers but only 35% for hogs. Finally, there is some evidence that the USDA's price forecasting accuracy has improved over time for broilers, but it has gotten marginally worse for hogs. Keywords: forecast evaluation, forecast efficiency, USDA forecasts

 
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Risk Management Techniques for Agricultural Cooperatives: An Empirical Evaluation
Mark Manfredo, Timothy Richards, and Scott Mcdermott
Year: 2003
 

Abstract

While not ignoring risk, agricultural cooperatives tend to accommodate risk through the holding of internal capital reserves rather than engage in active risk management. A lack of information regarding the risk, returns, and the effect on cooperative financial performance of both traditional and innovative risk management strategies is likely a constraint to the adoption of active risk management by cooperatives. In this research, we examine the influence of alternative risk management strategies on cooperative financial performance, namely the return on assets (ROA) of grain merchandising cooperatives of various sizes. Strategies include traditional exchange traded futures and options strategies, an over-the-counter revenue swap, throughput insurance, and combinations of price and throughput strategies. Each of these strategies, for small, medium, and large size firms, are evaluated using a range of procedures including techniques which rely on mean-variance efficiency as well as evaluation procedures which help determine the ability of a strategy to mitigate downside risk. The results of the simulation exercise provide considerable support for the routine buying of at-the-money put options in setting a commodity floor price. The results also support the use, and perhaps the development, of insurance on cooperative throughput if the insurance product is used in conjunction with a price risk management strategy, in essence providing a hedge against downfalls in revenue. Over-the-counter revenue swaps, while intuitively appealing, did not perform well on average relative to more traditional exchange traded products. This result is especially important given the added counter party risk associated with such contracts. However, in some cases, the revenue swap, as well routine hedging with futures, performed better under a Value-at-Risk evaluation criteria than with a mean-variance criteria. Hence, it is important for cooperative managers to consider these results in the context of the risk management goals.

 
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Evaluation of Market Advisory Service Performance in Hogs
Rick L. Webber, Scott H. Irwin, Darrel L. Good, and Joao Martines-Filho
Year: 2003
 

Abstract

The purpose of this paper is to investigate the pricing performance of agricultural market advisory services in hogs. Pricing recommendations are available for all quarters from the beginning of 1995 through the end of 2001. The results show that average differences between advisory programs and market benchmarks are small in nominal terms for all three benchmarks, -$0.41/bu., $O.OO/cwt. and $-0.27/cwt. versus the cash, index and empirical benchmarks, respectively, and none of the average differences are significantly different from zero. Hence, advisory programs as a group do not outperform the market benchmarks in terms of average price. Advisory programs also do not outperform the market benchmarks in terms of average price and risk. Finally, there is little evidence that advisory programs with superior performance can be usefully selected based on past performance in the hog market.

 
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Price Premiums from a Certified Feeder Calf Preconditioning Program
Clement E. Ward and David L. Lalman
Year: 2003
 

Abstract

Preconditioning calf programs, while not new, are becoming more prevalent. They provide benefits to cow-calf producers while adding value for feeder cattle buyers. However, questions remain regarding the marginal returns from marketing preconditioned calves exceeds the marginal costs for preconditioning. This paper reports estimates from two models to determine the premium paid by feeder cattle buyers for preconditioned calves in the Oklahoma Quality Beef Network (OQBN) program. One model assumes feeder calf characteristics are independent as most previous research. The other assumes interdependency between several characteristics that are affected by preconditioning. Data were from seven feeder calf sales in Oklahoma in 2001 and another seven sales in 2002. Estimated price premiums for OQBN certified calves from the second model were typically higher and more consisted across sales than were the price premiums from the first model. Keywords: Animal health, Feeder cattle, Hedonic models, Marketing, Preconditioning, Prices, Value-added

 
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Determinants of Beef and Pork Brand Equity
Joe L. Parcell and Ted Schroeder
Year: 2003
 

Abstract

A set of consumer-level characteristic demand models were estimated to determine the level of brand equity for pork and beef meat cuts. Results indicate that brand premiums and discounts vary by private, national, and store brands; and brand equity varies across meat cuts carrying the same brand name. Other results are that product size discounts are linear, meat items on sale are significantly discounted to non-sale items, specialty stores typically do not garner higher prices than supermarket/grocery store, and warehouse/super center stores typically premium price to supermarket/ grocery store.

 
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