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Smart Money? The Forecasting Ability of CFTC Large Traders
Dwight R. Sanders, Scott H. Irwin, and Robert Merrin
Year: 2007
 

Abstract

The forecasting ability of the Commodity Futures Trading Commission’s Commitment’s of Traders data set is investigated. Bivariate Granger causality tests show very little evidence that traders’ positions are useful in forecasting (leading) market returns. However, there is substantial evidence that traders respond to price changes. In particular, non-commercial traders display a tendency for trend-following. The other trader classifications display mixed styles, perhaps indicating that those trader categories capture a variety of traders. The results generally do not support the use of the Commitment’s of Traders data in predicting market movements.

 
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Inventory and Transformation Hedging Effectiveness in Corn Crushing
Roger A. Dahlgran
Year: 2007
 

Abstract

In response to the development of the U.S. ethanol industry, the Chicago Board of Trade (CBOT) launched the ethanol futures contract in March 2005. This contract is promoted by the CBOT as allowing ethanol producers to hedge corn crushing using strategies similar to those used in soybean crushing. The similarities end, however, when the lack of short-term correlation between corn and ethanol prices is compared to the strong correlation between soybean and soy product prices. This contrast motivates the examination of the price risk management capabilities of the CBOT’s ethanol futures contract.

Standard hedging methodology is applied to weekly cash and futures price data from March 23, 2005 through March 7, 2007. Findings include (1) for two- to eight-week hedging horizons, the ethanol futures contract effectively hedges ethanol inventory price risk. The effectiveness of the hedge increases with the hedging horizon. Thus, ethanol producers and brokers can use the ethanol futures market to reduce the price risk of holding ethanol inventories. (2) Contrary to anecdotal evidence, ethanol futures are not significantly inferior to gasoline futures for hedging ethanol price risk and for a four-week hedge they are significantly superior to gasoline futures. Thus, ethanol producers and brokers get greater price risk protection from hedging with ethanol futures than with gasoline futures. (3) The corn crushing hedge, utilizing corn and ethanol futures contracts, is an effective means to “lock in” a processing margin. The effectiveness of this hedge increases as the hedging horizon increases. Finally, to understand the processing hedge, the corn crush hedge and the soybean crush hedge were compared. I found that (4) the price risk of corn crushing is greater than that of soybean crushing and the effectiveness of corn crush hedging exceeds that of soybean crush hedging. This difference is explained by the high correlations in the soybean complex.

 
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Economics of Increased Beef Grader Accuracy
Maro A. Ibarburu, John D. Lawrence, and Darrell Busby
Year: 2007
 

Abstract

Carcass data from more than 38,000 cattle was used to compare the called and measured yield grade in two different periods: before and after the slaughter plant incorporated another grader in the line to improve grading accuracy. The study shows that the graders accuracy significantly increased. The higher accuracy affected all yield grades, but most notably resulted in more called yield grade 4 and 5 carcasses. This analysis will develop insight of what will be the effect of instrument grading that will be more accurate than previously called grades.

The results are expressed as the conditional distribution of the called yield grade for a given value of the measured yield grade. The pricing grid currently used by the industry was used to analyze the effect of the graders errors on the expected values of the remiums on both periods and by yield grade. The results show that the company has an incentive to improve accuracy of grading. Simulating the results of measured vs. called yield grade over prices at the time and a standard industry grid showed that the plant can benefit by $1.32 per head by increasing grading accuracy.

 
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Impacts of Alternative Marketing Agreement Cattle Procurement Volumes on Packer Costs: Evidence from Plant-Level P&L Data
Stephen R. Koontz, Mary K. Muth, and John D. Lawrence
Year: 2007
 

Abstract

It has been argued that access to captive supply cattle improve the economic efficiency of beef packing facilities. However, this argument has not been subject to hypothesis testing. This work models the cost efficiencies associated with captive supplies or cattle we refer to as being sourced through alternative marketing agreements (AMAs). We find that slaughter and processing costs are lower ceteris paribus for AMA cattle than for cash market cattle. We find that plants that slaughter cattle from AMA sources operate at higher monthly volumes ceteris paribus and lower average costs per head. And we find that plants that slaughter cattle from AMA sources have more predictable volumes ceteris paribus and have lower average costs per head. If AMAs were limited or prohibited then packing industry efficiency would be negatively impacted and that fed cattle prices would be negatively impacted.

 
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Economic Analysis of Pharmaceutical Technologies in Modern Beef Production
John D. Lawrence and Maro A. Ibarburu
Year: 2007
 

Abstract

Cattle production is the largest single agricultural sector in the U.S. with cash receipts of $49.2 billion in 2005. Like the rest of agriculture cattle producers have adopted efficiency and quality improving technology to meet consumer demands for a safe, wholesome, and affordable food supply. This research uses meta analysis to combine over 170 research trials evaluating pharmaceutical technologies in the cow-calf, stocker, and feedlot segments of beef production. These results were used to estimate the farm level economic value of parasite control, growth promotant implants, sub-therapeutic antibiotics, ionophores, and beta agonists for the industry in 2005. The Food and Agriculture Policy Research Institute (FAPRI) model of U.S. agriculture was used to estimate the impact on beef production, price, and trade and the rest of agriculture if these pharmaceutical technologies were not available.

Using 2005 prices and production levels the cost savings of the five pharmaceutical technologies evaluated was over $360 head over the lifetime of the animal. Selling prices would have to increase 36% to cover the increase in costs. The resulting industry would have a similar beef cow inventory, lower beef production, and higher prices from retail through to producers. However, the higher prices do not fully offset the higher cost of production.

Some consumers are requesting “natural” or organically produced beef and a portion of consumers are willing to pay a premium for these products. However, if pharmaceutical technologies were not available in the US cost of production would rise forcing some producers and resources out of cattle production. The smaller industry and domestic beef supply, increased net beef imports, and higher prices to all consumers.

 
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Meat Processors Purchasing and Sale Practices: Lessons Learned from the GIPSA Livestock and Meat Marketing Study
John D. Lawrence, Mary K. Muth, Justin Taylor, and Stephen R. Koontz
Year: 2007
 

Abstract

The meat value chain is a complex organization with multiple participants performing numerous value added functions. Perhaps the most complex and least well understood segment is that downstream from the packer, e.g., the processor, wholesaler, exporter, retailer and food service (or restaurant) operator. One portion of the Livestock and Meat Marketing Study provided an overview of marketing and pricing methods used in this sector and, in particular, the results of analyses of the relationship between use of alternative marketing arrangements (AMAs) and the distribution and sales of meat products downstream from the packer. The analyses include both beef and pork products, are descriptive and focus on the relationships among industry participants beyond the packing plant. The information used includes the results of the industry interviews, data from the industry surveys, and transactions data from meat processors.

Primary conclusions related to meat processing, distribution, and sales, are as follows:

• Firms differ greatly in the sales, purchase, and pricing methods for meat. Firms rely heavily on the spot market but also use other methods. They also mix-and-match purchase and pricing methods, e.g., buying on the forward market, but pricing on a formula.

• Meat processors play an important distribution role in the meat value chain by purchasing large lots from a few sources and selling small lots to many firms.

• Packers sort cattle purchased under various marketing arrangements to meet the needs of its buyers, but aggregate transactions data suggest that downstream marketing arrangements have little or no relationship to cattle purchase methods or branded beef sales programs.

 
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Information Content in Deferred Futures Prices: Live Cattle and Hogs
Dwight R. Sanders, Philip Garcia, and Mark R. Manfredo
Year: 2007
 

Abstract

The marginal forecast information contained in deferred futures prices is evaluated using the direct test of Vuchelen and Gutierrez. In particular, the informational role of deferred futures contracts in live cattle and hogs is assessed from the two- to twelve-month horizons. The results indicate that unique information is contained in live cattle futures prices out through the ten-month horizon, while hog futures prices add incremental information at all tested horizons. Practitioners using futures-based forecasting methods are well-served by deferred hog futures prices; however, live cattle futures listed beyond the 10 month horizon are not adding incremental information.

 
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Do Big Crops Get Bigger and Small Crops Get Smaller? Further Evidence on Smoothing in USDA Crop Production Forecasts
Olga Isengildina-Massa, Scott H. Irwin, and Darrel L. Good
Year: 2007
 

Abstract

The purpose of this paper is to determine whether smoothing in USDA corn and soybean production forecasts is concentrated in years with relatively small and large crops. The sample consists of all USDA corn and soybean production forecasts released over the 1970 through 2006 crop years. Results show that USDA crop production forecasts in both corn and soybeans have a marked tendency to decrease in small crop years and increase in big crop years. The magnitude of smoothing is surprisingly large, with corn and soybean production forecasts cumulatively revised downward by about 6 to 7 percent in small crop years and upward by about 5 to 6 percent in large crop years. Crop condition ratings are useful in predicting whether the current year is likely to be a small, normal, or big crop year. Hence, there appears to be an opportunity for the USDA to incorporate additional information into the forecasting process to reduce or eliminate the smoothing inherent in different types of crop years.

 
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The Cattle Price Cycle: An Exploration in Simulation
Matthew C. Stockton and Larry W. Van Tassell
Year: 2007
 

Abstract

The simulation of commodity prices has been undertaken using a myriad of techniques, with some omitting the cyclical component and others ignoring the presence of inter-temporal relationships expressed as autoregressive errors. This study examines the periodicity of cattle prices and the modeling of the cattle cycle for simulation purposes. The AIC criterion is used to determine lengths of various cycles to be included in a harmonic model, with a chained modeling approach providing the best representation of the cattle cycle.

 
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The Effect of Ethanol Production on the U.S. National Corn Price
Hwanil Park and T. Randall Fortenbery
Year: 2007
 

Abstract

A system of equations representing corn supply, feed demand, export demand, food, alcohol and industrial (FAI) demand, and corn price is estimated by three-stage least squares. A price dependent reduced form equation is then formed to investigate the effect of ethanol production on the national average corn price. The elasticity of corn price with respect to ethanol production is then obtained. Results suggest that ethanol production has a positive impact on the national corn price and that the demand from FAI has a greater impact on the corn price than other demand categories. Thus, significant growth in ethanol production is important in explaining corn price determination.

 
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Cross-Hedging Distillers Dried Grains: Exploring Corn and Soybean Meal Futures Contracts
Adam Brinker, Joe Parcell, and Kevin Dhuyvetter
Year: 2007
 

Abstract

Ethanol mandates and high fuel prices have led to an increase in the number of ethanol plants in the U.S. in recent years. In turn, this has led to an increase in the production of distillers dried grains (DDGs) as a co-product of ethanol production. DDG production in 2006 is estimated to be near 11 million tons. A sharp increase in ethanol production and thus DDGs is expected in 2007 with an increase with the number of ethanol plants. As with most competitive industries, there is some level of price risk in handling DDGs and no futures contract available for this co-product. Ethanol plants, as well as users of DDGs, may find cross-hedging DDGs with corn or soybean meal (SBM) futures as an effective means of managing risk. Traditionally, DDGs are hedged using only corn futures.

 
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Measuring the Influence of Commodity Fund Trading on Soybean Price Discovery
Gerald Plato and Linwood Hoffman
Year: 2007
 

Abstract

The increase in commodity fund trading in the agricultural commodity futures markets has raised concern that this trading is degrading the price discovery performance of these markets. We used the Beveridge-Nelson Decomposition procedure to estimate the price discovery performance of the soybean futures and spot markets. We found that the price discovery performance of the soybean futures market has improved along with the increased commodity fund trading. Our results indicated that a portion of the price discovered in the soybean futures market is passed to the spot market.

 
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Insights into Trader Behavior: Risk Aversion and Probability Weighting
Fabio Mattos, Philip Garcia, and Joost M.E. Pennings
Year: 2007
 

Abstract

The objective of this study is to investigate how professional traders in futures and options markets behave under risk and uncertainty. Our preliminary findings suggest that most traders exhibit concave utility functions for gains and convex utility functions for losses, while their weighting functions are inverse s-shaped. However, differences in magnitude of the risk aversion parameters and the degree of probability weighting can lead to distinct behavior even if the shapes of utility and weighting functions are the same. Further, the typical pattern of prospect theory is more prevalent under risk but not as much under uncertainty. More combinations of shapes for utility and weighting functions are found under uncertainty, suggesting that different types of behavior emerge when people need to make their own assessments about the likelihood of events. Finally, our results are consistent with evidence of loss aversion and disposition effect found in studies of trading behavior in futures markets.

 
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Profit Margin Hedging
Hyun Seok Kim, B. Wade Brorsen, and Kim B. Anderson
Year: 2007
 

Abstract

Some extension economists and others often recommend profit margin hedging in choosing the timing of crop sales. This paper determines producer’s utility function and price processes where profit margin hedging is optimal. Profit margin hedging is shown to be an optimal strategy under a highly restricted target utility function even in an efficient market. Although profit margin hedging is not the optimal rule in the presence of mean reversion, it can still be profitable if prices are mean reverting. Simulations are also conducted to compare the expected utility of profit margin hedging strategy with the expected utility of other strategy such as always hedging and selling at harvest strategies. A variance ratio test is conducted to test for the existence of mean reversion in agricultural futures prices process. The simulation results show that the expected utility of profit margin hedging strategy is highest. The paired difference tests for the profit margin hedging and other two strategies shows that the expected utilities of profit margin hedging strategies are not significantly different from those of always hedging strategy, but are significantly different from those of selling at harvest strategy except when the transaction cost is considered. The results of variance ratio test indicate that there is little evidence that futures price of wheat follows mean reverting process.

 
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Implicit Value of Retail Beef Brands and Retail Meat Product Attributes
Jennifer M. Dutton, Clement E. Ward, and Jayson L. Lusk
Year: 2007
 

Abstract

Consumers reveal preferences for fresh beef attributes through their retail beef purchases. Hedonic pricing methods were used to estimate the value consumers place on observable characteristics of fresh beef products, especially on retail beef brands. Primary data were collected from 65 randomly generated grocery stores located in three metropolitan areas, Oklahoma City and Tulsa, Oklahoma, and Denver, Colorado. Retail beef package data were collected on 462 ground products, 175 roast products, and 756 steak products.

There was some evidence retail beef brands command a price premium compared with unbranded, generic products. In this study, branding programs classified as “special” (i.e. no antibiotics, no hormones, all natural) offered the largest price premiums, but “other” types of branding programs offered price premiums as well. Price premiums for special brands were $1.45/lb. for ground products and $5.87/lb. for steak products. Labeling variables were not consistently significant in this study, indicating that labels associated with a brand name might offer consumers the most reassurance for their purchasing decision.

The most important attributes affecting retail price per pound of ground beef products are store location (metropolitan area), store type, type of product, fat content, package size and type, expiration dates, brands and labels. Store location (metropolitan area) was important but store type was less important for explaining steak items than ground items. Steak prices were influenced by cut type, USDA quality grade, package size and type, and slightly by expiration date.

 
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Measuring Liquidity Costs in Agricultural Futures Markets
Julieta Frank and Philip Garcia
Year: 2007
 

Abstract

Estimation of liquidity costs in agricultural futures markets is challenging because bid-ask spreads are usually not observed. Spread estimators that use transaction data are available, but little agreement exists on their relative accuracy and performance. We evaluate four conventional and a recently proposed Bayesian estimators using simulated data based on Roll’s standard liquidity cost model. The Bayesian estimator tracks Roll’s model relatively well except when the level of noise in the market is large. We derive an improved estimator that seems to have a higher performance even under high levels of noise which is common in agricultural futures markets. We also compute liquidity costs using data for hogs and cattle futures contracts trading on the Chicago Mercantile Exchange. The results obtained for market data are in line with the findings using simulated data.

 
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To What Surprises Do Hog Futures Markets Respond?
Julieta Frank, Philip Garcia, and Scott Irwin
Year: 2007
 

Abstract

We re-assess the effect of new information contained in the Hogs and Pigs Reports (HPR) focusing on the rationality of the announcements. We find that HPR preliminary numbers are irrational estimates of the final numbers and market expectations before the announcements are also irrational estimates of HPR numbers. Based on these results we modify the conventional measure of new information entering into the market (i.e., announcement - market expectation), and incorporate final estimates and the market’s best forecast into the analysis. Results show modest statistical differences between the conventional and modified measures of surprise; however some economic differences, as large as 27 cents/cwt, emerged. We also find that, as expected, marketings information has a larger effect on short-term price changes and breedings information has a larger effect on long-term price changes.

 
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Economically Optimal Distiller Grain Inclusion in Beef Feedlot Rations: Recognition of Omitted Factors
Crystal Jones, Glynn Tonsor, Roy Black, and Steven Rust
Year: 2007
 

Abstract

With the rapid expansion of the ethanol industry, the feeding landscape familiar to the feedlot industry is changing. While concerns regarding rising corn prices persist, many within the industry are looking at distiller’s grains, a by-product of ethanol production, to serve as a feed substitute. The question remains as to what extent these two feed sources are substitutable. The purpose of this study is to identify the economically optimal inclusion rate of distiller’s grains in beef feedlot rations, considering an array of often omitted factors. Most currently prevailing recommendation rates are strictly biologically based and frequently reference only one feeding trial. Unique economic factors considered in this research include the impact of by-product inclusion rates on animal performance (utilizing recently conducted meta-analysis from 17 relevant feeding trials), enhanced likelihood of death loss from heightened sulfur content, and manure disposal costs. Results indicate that excluding these factors can significantly impact optimal inclusion levels and that reliance on a single or few feeding trials may greatly bias results.

 
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Using Basis and Futures Prices as a Barometer in Deciding Whether to Store Grain or Not
Mounir Siaplay , Kim B. Anderson, and B.Wade Brorsen
Year: 2007
 

Abstract

The purpose of this paper is to determine the importance of the strength and weakness of basis and futures prices as barometers for producers to use in deciding whether to store or not. Basis is the single most important market signal for wheat producers to use when deciding whether to store or sell their wheat at harvest. While some models indicated low futures prices were a signal to store, results were fragile and inconsistent.

 
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Meat Slaughter and Processing Plants’ Traceability Levels Evidence From Iowa
Harun Bulut and John D. Lawrence
Year: 2007
 

Abstract

In the United States (U.S.), there is no uniform traceability regulation across food sector. Food and Drug Administration (FDA) implemented one-step back and one-step forward traceability over the industries under its jurisdiction. U.S. Department of Agriculture (USDA), which oversees meat, poultry and egg production, requires some record keeping as part of food safety regulation. Particularly, a two-part-system has developed; live animal traceability and meat traceability with slaughter and processing plants in between. This paper studies the question of whether (and if so how) meat plants’ traceability levels vary with respect to the following factors; product specific (credence versus experience and search attributes, branded versus commodity meat, being exporter), organizational (spot market versus contracting), food safety related, and plant specific (a quality assurance system in place, number of sources, size, capital-labor ratio, etc.).

 
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Outlook vs. Futures: Three Decades of Evidence in Hog and Cattle Markets
Evelyn V. Colino and Scott H. Irwin
Year: 2007
 

Abstract

The purpose of this paper is to provide a comprehensive evaluation of the accuracy of outlook forecasts relative to futures prices in hog and cattle markets. Published forecasts from four prominent livestock outlook programs are available for analysis. Most of the series begin in the mid- to late-1970s and end in 2006. Root mean squared error (RMSE) comparisons indicate, with one exception, no meaningful differences in forecast accuracy between outlook forecasts and futures prices. The null hypothesis that futures prices encompass outlook forecasts is rejected in 9 of 11 cases for hogs and 7 of 8 cases for cattle, clearly indicating that outlook forecasts provide incremental information not contained in futures prices. The magnitude of decline in RMSE from combining outlook forecasts and futures prices is non-trivial in almost all cases. The reduction in RMSE for composite forecasts averages -6.3% and -9.0% in hogs and cattle, respectively. Overall, the results of this study provide compelling evidence of the substantial economic value of public outlook programs in cattle and hogs.

 
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Differences in Prices and Price Risk across Alternative Marketing Arrangements Used in the Fed Cattle Industry
Mary K. Muth, Yanyan Liu, Stephen R. Koontz, and John D. Lawrence
Year: 2007
 

Abstract

Information on typical differences in prices and price risk (as measured by the variances of prices) across marketing arrangements aids fed cattle producers in making choices about methods to use for selling fed cattle to beef packers. This information is also useful for policy discussions on merits and drawbacks of alternative marketing arrangements. As part of the congressionally mandated Livestock and Meat Marketing Study, we investigated differences in prices and price risk for fed cattle cash market and alternative marketing arrangements. The modeling approach, which is similar to a hedonic model, controls for differences in cattle quality and delivery month and accounts for the within- and across-week correlation in prices. The analysis uses a recent data set for the October 2002 through March 2005 time period and includes sale lots of six or more cattle purchased by the 29 largest beef packing plants in the United States. The results indicate that marketing agreements, which are long-term ongoing agreements between fed cattle producers and packers that use formula pricing, offered the best trade-off between price level and price risk for both beef and dairy breed fed cattle. Prices were within $0.01 per pound carcass weight for both beef and dairy breed fed cattle sold under marketing agreements instead of through direct trade, but they were 18% to 20% less volatile. While auction barn prices were higher than all other methods, they were also the most volatile. Forward contracts had the lowest average price and the most volatile prices. The results also indicate that larger and higher quality lots were associated with higher average prices and lower variance of prices.

 
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The Impact of Measurement Error on Estimates of the Price Reaction to USDA Crop Reports
Nicole M. Aulerich, Scott H. Irwin, and Carl H. Nelson
Year: 2007
 

Abstract

This paper investigates the impact of USDA crop production reports in corn and soybean futures markets. The analysis is based on all corn and soybean production reports released over 1970-2006. The empirical analysis compares the typical OLS event study approach to the new Identification by Censoring (ITC) technique. Corn and soybean production reports are analyzed both separately and together for impact in corn and soybean futures prices. ITC proves to be the more useful method because it avoids the pitfalls of errors in variables that cause downward bias in OLS coefficients. Price reaction coefficients estimated via ITC are one to four times larger than OLS estimates for a one price and one event analysis. In the two price, two event case, ITC estimates are one to six times larger. Market reaction to the unanticipated information in USDA forecasts is substantially larger than estimated in previous studies.

 
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