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The Marketing Performance of Illinois Corn and Soybean Producers
Lewis A. Hagedorn, Scott H. Irwin, and Darrel L. Good
Year: 2004
 

Abstract

Marketing is viewed as an important component of the farm management process, and poor marketing is often cited as a cause of low farm incomes. However, widespread beliefs about poor performance are not based upon a large body of research, and available evidence is too limited to make definitive conclusions about farmer marketing abilities. This paper examines the actual marketing performance of corn and soybean producers in Illinois. Farmer marketing data is based on the USDA’s “Average Producer Price Received” over the period 1975-2002. Marketing performance is assessed using 20- and 24-month average price market benchmarks. A comparison of farmer prices received to the price range for each crop year reveals that in the majority of years producers market their crop in the top- or middle-third of the price range. Despite these findings, farmer prices fell below the average price offered by the market in most normal crop years; weighting these shortfalls by actual production reveals substantial, avoidable income loss. In short crop years, however, farmer prices exceeded the market benchmarks for both crops. Observed farmer marketing performance is explained in the context of price and marketing patterns; farmers appear to market too much of their crop in the latter part of the marketing year, when, in most years, prices are at their lowest. Shifting a portion of sales to the pre-harvest period is proposed as a likely means of improving farmer marketing performance and easing avoidable income loss.

 
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Portfolios of Agricultural Market Advisory Services: How Much Diversification is Enough?
Silvina M. Cabrini, Brian G. Stark, Scott H. Irwin, Darrel L. Good, and Joao Martines-Filho
Year: 2004
 

Abstract

This study analyzes the potential risk reduction gains from naïve diversification (equal-weighting) among market advisory services for corn and soybeans. The total possible decrease in risk through naïve diversification is small, mainly because advisory prices are highly correlated on average. Moreover, since marginal risk reduction benefits decrease rapidly with size, and the cost of holding the portfolios increases linearly due to services’ subscription fees, it is optimal to limit portfolio size to a few advisory programs. Based on certainty equivalent measures and two representative risk aversion levels, preferred portfolio sizes are between one and three services. Overall, there does not appear to be strong justification for farmers adopting portfolios with numerous advisory services.

 
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Options-Based Forecasts of Futures Prices in the Presence of Limit Moves
Thorsten M. Egelkraut and Philip Garcia
Year: 2004
 

Abstract

This analysis examines a simultaneous estimation option-based approach to forecast futures prices in the presence of daily price limit moves. The procedure explicitly allows for changing implied volatilities by estimating the implied futures price and the implied volatility simultaneously. Using 15 years of futures and futures options data for three agricultural commodities, we find that the simultaneous estimation approach accounts for the abrupt changes in implied volatility associated with limit moves and generates more accurate price forecasts than conventional methods that rely on only one implied variable.

 
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Are Revisions to USDA Crop Production Forecasts Smoothed?
Olga Isengildina, Scott H. Irwin, and Darrel L. Good
Year: 2004
 

Abstract

This study investigates the nature of the revision process of USDA corn and soybean production forecasts over the 1970/71 through 2002/03 marketing years. Nordhaus’ framework for testing the efficiency of fixed-event forecasts is used. In this framework, efficiency is based on independence of forecast revisions. Both parametric and non-parametric tests reject independence of consecutive forecast revisions. Positive correlation and consistency of directional changes in forecast revisions suggest that these forecasts are “smoothed.” Estimates of the impact of smoothing on forecast accuracy show that correction for smoothing may result in economically meaningful improvements in accuracy.

 
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Hedging-Effectiveness of Milk Futures Using Value-At-Risk Procedures
Ibrahim Bamba and Leigh Maynard
Year: 2004
 

Abstract

The effectiveness of the Class III Milk futures market is analyzed in terms of the reduction in Value-at-Risk (VaR) for milk producers located in four regions: Wisconsin, Northeast, Florida and California. Constant hedge ratios are estimated using Myers and Thompson’s (1989) generalized conditional hedge ratio technique, and time-varying hedge ratios are estimated using an exponentially weighted moving average method. After defining milk price risk as the deviation of the ctual milk price from its expected value, the effectiveness of uniform hedging strategies in the Class III milk futures market is assessed using three popular methods for VaR calculations: the parametric method, the historical method, and the Monte Carlo simulation ethod. The results suggest that uniform hedging strategies can reduce substantially the VaR of milk cash price for appropriately chosen hedge length and hedge signals. For example, a uniform hedge placed seven months prior to delivery and triggered at $11.00 cwt reduces the mailbox price tail risk more than the same uniform hedging established four months before delivery. As expected the higher the Class III utilization the more effective hedging seems. The magnitude of the hedging effectiveness seems to depend more on the hedge length and the hedge trigger than on the methodology used to obtain the hedge ratio or the VaR.

 
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Cash Marketing Styles and Performance Persistence of Wheat Producers
Lewis T. Cunningham Iii, B. Wade Brorsen, and Kim B. Anderson
Year: 2004
 

Abstract

Years of research have been dedicated to determining the best time for producers to sell their commodities. Researchers have developed basis models, market efficiency tests, hedging/risk models, price forecasting models, and many other models in an attempt to help producers. There is a vast amount of material on how economists believe that a rational producer should act and react in the market place. However, there is little research on how producers actually sell commodities. This paper first measures the extent to which producers display an active or mechanical marketing style using individual farmer sales. Next, tests of performance persistence are conducted to determine if there is any advantage to an active marketing style. The results show that southern Oklahoma wheat producers tend to have a mechanical marketing style, while at other locations producers appear to have a more active style. The results show no evidence of performance persistence and thus suggest that there is no advantage to using an active marketing style.

 
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Weather Derivatives in the Presence of Index and Geographical Basis Risk: Hedging Dairy Profit Risk
Gang Chen and Matthew C. Roberts
Year: 2004
 

Abstract

Weather conditions pose unique risks to dairy producers. Weather derivatives represent a potentially promising approach to augment dairy producers’ risk management against adverse weather events. This study examines the effect of basis risk in weather derivatives, and whether the existence of basis risk mitigates the usefulness of weather derivatives for dairy risk management. Assuming a representative dairy producer has access to both weather derivatives and traditional heat abatement equipment, a closed-form solution for his/her optimal portfolio choice problem in the presence of basis risk is derived within a mean-variance utility framework. First-, second-, and third- degree stochastic dominance criteria are used to test the risk management effectiveness with less restrictive assumptions. Also proportional transaction costs are imposed on weather derivative prices calculated on the basis of actuarial fairness to allow the desirability of these contracts to their issuers.

 
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Perceptions of Futures Market Liquidity: An Empirical Study of CBOT & CME Traders
Julia W. Marsh, Joost M.E. Pennings and Philip Garcia
Year: 2004
 

Abstract

Traders’ perceptions drive their market behavior, and can influence the dynamics of liquidity. This study surveyed 420 traders on their perceptions of the price path during an order imbalance to better understand the dynamics of liquidity. While most liquidity models assume a linear price path, only 12% of traders perceive such a path. This raises questions on the validity of such models. There is considerable heterogeneity in the perceptions of the price path. While trader characteristics are often used to classify traders, trader characteristics do not explain the heterogeneity in perceptions. On the other hand, traders of a specific contract are associated with particular perceptions of the price path. This indicates that market microstructure may be the primary driver of traders’ perceptions of the price path.

 
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Accuracy of Grid Pricing: An Evaluation Using Wholesale Values of Fed Cattle
Joseph T. Kovanda, Ted C. Schroeder, and Tommy L. Wheeler
Year: 2004
 

Abstract

Grid pricing is one of the beef industry’s answers to improving value coordination in fed cattle transactions. This paper constructs individual carcass-level grid and wholesale beef values. These values are used to evaluate the level of value communication that occurs between wholesale and grid values of beef. Furthermore, the values are used to estimate grid premiums/discounts that improve value communication. Results indicate that value coordination could be improved by modifying grid premiums/discounts.

 
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Price Discovery in Thinly Traded Markets: Cash and Futures Relationships in Brazilian Agricultural Futures Markets
Fabio Mattos and Philip Garcia
Year: 2004
 

Abstract

This study investigates the relationship between cash and futures prices in the Brazilian agricultural market, focusing on the effects of trading activity on the price discovery mechanism of futures markets. The results are mixed, but several points begin to emerge. In general, higher trading activity is linked to the presence of long-run equilibrium relationships between cash and futures prices. In these cases, futures prices appear to play a more dominant role in the pricing process. In more lightly traded markets, neither long-run relationships nor short-run leads and lags can be found. Where short-run interactions exist, they are simultaneous in nature but weak. Overall, our findings suggest that the level of market activity necessary to develop interactive cash and futures markets is surprisingly small.

 
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Transaction Frequency, Inventories and Hedging in Commodity Processing
Roger A. Dahlgran
Year: 2004
 

Abstract

This study examines hedging strategies for commodity processors generally and soybean crushers specifically. Processors require hedging strategies built around processing multiple batches each year. Each batch requires the purchase of inputs, transformation of inputs into outputs, and sale of the resulting output. The more batches processed, the greater the transaction frequency, the smaller each batch's size. Increased transaction frequency reduces risk because of the smaller batch size. This study distinguishes between batch (accounting) profits and periodic profits (cash flows). Traditional hedging models have focused on batch profits but we argue that hedging cash flows are also a legitimate hedging target because (a) discounted cash flow is the capital investment decision criterion, (b) costs are associated with managing working capital, (c) cash flow and profits converge in annual aggregation, and (d) stabilizing periodic cash flow stabilizes annual profits but the converse does not hold. Weekly cash and futures prices from 1990 through 2003 are used to compare averages and standard deviations of direct-hedged and unhedged profits and cash flows with transaction frequencies of 1, 2, 4, 13, 26 and 52 weeks. Our findings are as follows. (1) Increased transaction frequency reduces the variance of unhedged profits and cash flows. Two effects account for this. Both profit and cash flow risks are reduced by smaller batch size associated with increased transaction frequency but only profit risk is reduced by closer integration of input and output markets as transaction frequency increases. (2) As transaction frequency increases, the amount of hedgeable risk declines (finding 1) and the effectiveness of traditional hedges also declines. (3) Anticipatory hedging of soybean processing does not offer much risk protection. (4) Traditional hedging of batch profits tends to destabilize periodic cash flows. Several areas meriting additional investigation are also discussed.

 
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Using Futures Prices to Forecast the Season-Average U.S. Corn Price
Linwood Hoffman
Year: 2004
 

Abstract

A model is developed using basis values (cash prices less futures), marketing weights, and a composite of monthly futures and cash prices to forecast the season-average U.S. corn farm price. Forecast accuracy measures include the absolute percentage error, mean absolute percentage error, squared error, and mean squared error. The futures model forecasts are compared to USDA’s WASDE projections. No statistically significance difference was found between the futures model forecasts and the season-average price projections from the U.S. Department of Agriculture. Futures model forecasts are reliable, and timely.

 
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The Performance of Weather Derivatives in Managing Risks of Specialty Crops
Trevor A. Fleege, Timothy J. Richards, Mark R. Manfredo, and Dwight R. Sanders
Year: 2004
 

Abstract

California specialty crop growers are exposed to extreme price volatility, as well as considerable yield volatility caused by fluctuations in temperature, precipitation, and other specific weather events. Weather derivatives do provide a promising market-based solution to managing risks for specialty crops. While previous weather derivatives research has focused on the pricing of weather options, little if any research has been conducted evaluating the hedging effectiveness of these instruments in practical risk management settings. Therefore, this research examines the hedging effectiveness of weather derivative strategies for nectarines, raisin grapes, and almonds in Central California. Estimates of the yield-weather relationships for these crops are found to be non-linear, suggesting a straddle strategy (long put and long call) in weather options. Simulation results also suggest that specialty crop producers can improve their net income distribution through the use of weather derivative strategies. This is particularly true when the correlation between price and yields is low.

 
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Evaluating Forecasts of Discrete Variables: Predicting Cattle Quality Grades
Bailey Norwood, Jayson Lusk and Wade Brorsen
Year: 2004
 

Abstract

Little research has been conducted on evaluating out-of-sample forecasts of limited dependent variables. This study describes the large and small sample properties of two forecast evaluation techniques for limited dependent variables: receiver-operator curves and out-of-sample-log-likelihood functions. The methods are shown to provide identical model rankings in large samples and similar rankings in small samples. The likelihood function method is slightly better at detecting forecast accuracy in small samples, while receiver-operator curves are better at comparing forecasts across different data. By improving forecasts of fed-cattle quality grades, the forecast evaluation methods are shown to increase cattle marketing revenues by $2.59/head.

 
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Re-Considering the Necessary Condition for Futures Market Efficiency: An Application to Dairy Futures
Dwight R. Sanders and Mark R. Manfredo
Year: 2004
 

Abstract

The traditional necessary condition for futures market inefficiency is the existence of alternative forecasting methods that produce mean squared forecast errors smaller than the futures market. Here, a more exacting requirement for futures market efficiency is proposed—forecast encompassing. Using the procedure of Harvey and Newbold, multiple forecast encompassing is tested with the CME fluid milk futures contract. Time series models and experts at the USDA provide the competing forecasts. The results suggest that the CME fluid milk futures do not encompass the information contained in the USDA forecasts at a two-quarter forecast horizon.

 
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Commodity Prices and Unit Root Tests
Dabin Wang and William G. Tomek
Year: 2004
 

Abstract

Endogenous variables in structural models of agricultural commodity markets are typically treated as stationary. Yet, tests for unit roots have rather frequently implied that commodity prices are not stationary. This seeming inconsistency is investigated by focusing on alternative specifications of unit root tests. We apply various specifications to Illinois farm prices of corn, soybeans, barrows and gilts, and milk for the 1960 through 2002 time span. The preponderance of the evidence suggests that nominal prices do not have unit roots, but under certain specifications, the null hypothesis of a unit root cannot be rejected, particularly when the logarithms of prices are used. If the test specification does not account for a structural change that shifts the mean of the variable, the results are biased toward concluding that a unit root exists. In general, the evidence does not favor the existence of unit roots.

 
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Optimal Hedging with Views: A Bayesian Approach
Wei Shi and Scott H. Irwin
Year: 2004
 

Abstract

The optimal hedging model has become the standard theoretical model of normative hedging behavior due to its intuitive tradeo® of expected return with risk, its e±cient use of information and its easy implementation. In practice, the model can be easily implemented with the Parameter Certainty Equivalent procedure, which substitutes sample estimates for the true but unknown model parameters. But subjective views, which refer to opinions concerning the directions of market returns of the assets involved in hedging decisions, are either completely ignored or handled in an ad hoc and unsatisfactory manner within the optimal hedging model. Given the widespread use of subjective views in hedging practice and the potential economic bene¯t of selective hedging, the lack of accommodation of subjective views in the optimal hedging model is a serious problem and could hamper the model's application in risk management practice. With an empirical Bayesian approach adopted, this study proposes an alternative Bayesian optimal hedging model, in which a hedger can adjust his/her optimal hedging position (ratio) according to his/her view(s) on the expected returns of assets under consideration. Like Lence and Hayes' Bayesian optimal hedging model (1994a, 1994b), the optimal hedging position is also determined by mean-variance optimization conditioned on the predictive expectation vector and predictive covariance matrix of asset returns, but unlike their model, the number and type of subjective views that can be expressed is quite °exible because of the adoption of an empirical Bayesian approach. The empirical Bayesian optimal hedging model provides practitioners with a theoretically intuitive yet quantitatively rigorous framework to blend subjective views and the market consensus estimated from sample data according to their relative con-dence levels.

 
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What Is “The Basis,” How Is It Measured, and Why Does It Matter?
Paul Peterson, Jack Cook, and Charles Piszczor
Year: 2004
 

Abstract

Basis behavior is generally considered to be the major determinant of hedging success or failure. In the course of our work as contract designers for Chicago Mercantile Exchange Inc., we have come to the conclusion that there are many misconceptions and incorrect statements made about “the basis” among practitioners and academics alike. Our work suggests that basis values, how they are measured, what they represent and how they are interpreted may differ widely from one commodity contract to another due to differences in the specifications of the underlying futures market, as well as differences in the structure of the underlying cash market.

 
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Contract Market Viability
Gordon C. Rausser and Henry L. Bryant
Year: 2004
 

Abstract

Academia and the finance industry generate many proposals for new contract markets. Unfortunately, many proposed markets lack the critical attributes that promote success. We examine these attributes, and evaluate the potential of several announced proposals. We find that proposals emanating from the academy generally fail to consider the full suite of integrated financial services necessary to support a viable market, while proposals put forward by practitioners are much more likely to do so.

 
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Incorporating Current Information into Historical-Average-Based Forecasts to Improve Crop Price Basis Forecasts
Mykel Taylor, Kevin C. Dhuyvetter, and Terry L. Kastens
Year: 2004
 

Abstract

Being able to accurately predict basis is critical for making marketing and management decisions. Basis forecasts can be used along with futures prices to provide cash price projections. Additionally, basis forecasts are needed to evaluate hedging opportunities. Many studies have examined factors affecting basis but few have explicitly examined the ability to forecast basis. Studies have shown basis forecasts based on simple historical averages compare favorably with more complex forecasting models. However, these studies typically have considered only a 3-year historical average for forecasting basis. This research compares practical methods of forecasting basis for wheat, soybeans, corn, and milo (grain sorghum) in Kansas. Across most of the multiple-year forecast methods considered, absolute basis forecast errors were slightly higher for the harvest forecasts than the post-harvest forecasts. Using an historical 3-year average to forecast basis for wheat and soybeans was optimal as compared to other multiple-year forecasts. For corn and milo, a 2-year average was the optimal multiple-year forecast method. Incorporating current market information, such as current nearby basis deviation from an historical average, into a harvest basis forecast improves accuracy for only the 4 weeks ahead of harvest vantage point, but improves the accuracy of post-harvest basis forecasts (24 weeks after harvest) from nearly all vantage points considered.

 
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Captive Supply Trends and Impacts since the Advent of Mandatory Price Reporting
Clement E. Ward and Jonathan T. Hornung
Year: 2004
 

Abstract

Captive supplies have been a contentious issue in the livestock industry for fifteen years and the subject of both theoretical and empirical research. In 2001, mandatory price reporting was implemented. One objective by its proponents was to increase the amount of information available on captive supplies. This paper examines data now available as a result of mandatory price reporting to determine what additional information is available compared to previously. Second, several models were specified and estimated to determine the impacts captive supplies had on fed cattle prices in the two years following implementation of mandatory price reporting. Models showed mixed results. There was a consistent negative effect on cash market prices from formula priced trades; generally a positive impact from negotiated trades and packer owned trades on cash market prices; and mixed but often a positive impact from forward contract trades on cash market prices.

 
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Performance of Selected Pre-harvest and Post-harvest Corn and Soybean Marketing Strategies vs. Alternative Market Benchmarks
E. Neal Blue, Robert N. Wisner, and E. Dean Baldwin
Year: 2004
 

Abstract

This study was undertaken to update earlier work by the authors that analyzed selected preharvest pricing strategies utilizing options markets to establish a price floor for part of the crop in the spring, with additional pricing done by use of short hedges in early summer. The timing of implementing these strategies was moved back to late February if the previous year’s U.S. crop was a weather-induced short crop. A weather-induced short crop as opposed to a government program induced short crop was defined as one in which U.S. production fell below the previous year’s use and the U.S. average yield was at least 6% below a trend yield. Previous work by the authors indicated that selected pre-harvest strategies applied to actual farms in Iowa and Ohio over the 1985-1998 time period generated net returns well above those from a naïve strategy of systematically selling at harvest, with t-tests indicating statistical significance at the 5% level. Similar results were observed when the time period was extended to 2001. The results from this study may explain the observed increase in the use of forward pricing by farmers, the emergence of new pre-harvest marketing tools focusing on late winter and spring pricing opportunities, and the emphasis on pre-harvest pricing by market advisory services (Irwin et al., 2003). Results reported here suggest that over the past 18 to 29 years, farmers have had the potential to reap substantial economic benefits from improving both their pre-harvest and post-harvest marketing skills.

 
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The Profitability of Technical Trading Rules in US Futures Markets: A Data Snooping Free Test
Cheol-Ho Park and Scott H. Irwin
Year: 2004
 

Abstract

Numerous empirical studies have investigated the profitability of technical trading rules in a wide variety of markets, and many of them found positive profits. Despite positive evidence about profitability and improvements in testing procedures, skepticism about technical trading profits remains widespread among academics mainly due to data snooping problems. This research tries to mitigate the problems by confirming the results of a previous study and then replicating the original testing procedure on new data. Results indicate that for various futures contracts and technical trading systems tested, technical trading profits have gradually declined over time. In general, substantial technical trading profits in the early 1980s are no longer available in the subsequent period.

 
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Generalized Hedge Ratio Estimation With an Unkown Model
Jeffrey H. Dorfman and Dwight R. Sanders
Year: 2004
 

Abstract

Myers and Thompson (1989) pioneered the concept of a generalized approach to estimating hedge ratios, pointing out that the model specification could have a large impact on the hedge ratio estimated. While a huge empirical literature exists on estimating hedge ratios, the literature is lacking a formal treatment of model specification uncertainty. This research accomplishes that task by taking a Bayesian approach to hedge ratio estimation, where specification uncertainty is explicitly modeled. Specifically, we present a Bayesian approach to hedge ratio estimation that integrates over model specification uncertainty, yielding an optimal hedge ratio estimator that is robust to possible model specification because it is an average across a set of hedge ratios conditional on di erent models. Model specifications vary by exogenous variables (such as exports, stocks, and interest rates) and lag lengths included. The methodology is applied to data on corn and soybeans and results show the potential benefits and insights gained from such an approach.

 
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