NCCC-134
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The Effect of Prior Gains and Losses on Current Risk-Taking Using Quantile Regression
Fabio Mattos and Philip Garcia
Year: 2009
 

Abstract

This paper investigates the dynamics of sequential decision-making in agricultural futures and options markets using a quantile regression framework. Analysis of trading records of 12 traders suggests that there is great heterogeneity in individual trading behavior. Traders respond differently to prior profits depending on how much risk their portfolios are carrying. In general, no significant response is found at average and below-average levels of risk, but response can become large and significant at above-average levels of risk. These results are consistent with studies which argued that behavior may be uneven under different circumstances, and calls into question the adoption of conditional mean framework to investigate trading behavior. Focusing the analysis on the effect of prior profits on the conditional mean of the risk distribution can yield misleading results about dynamic behavior.

 
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Does Futures Price Volatility Differ Across Delivery Horizon?
Berna Karali, Jeffrey H. Dorfman, and Walter N. Thurman
Year: 2009
 

Abstract

We study the difference in the volatility dynamics of CBOT corn, soybeans, and oats futures prices across different delivery horizons via the smoothed Bayesian estimator of Karali, Dorfman, and Thurman (2010). We show that the futures price volatilities in these markets are affected by the inventories, time to delivery, and the crop progress period. Some of these effects vary across delivery horizons. Further, it is shown that the price volatility is higher before the harvest starts in most of the cases compared to the volatility during the planting period. These results have implications for hedging, options pricing, and the setting of margin requirements.

 
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Evaluating the Dynamic Nature of Market Risk
Todd Hubbs, Todd H. Kuethe and Timothy G. Baker
Year: 2009
 

Abstract

This study examines the systematic risk present in major crops for the United States and three corn-belt states. An index of commodities is used in conjunction with cash receipts to generate dynamic estimates of the systematic risk for each crop and state. In our study, we find that beta estimates from a time varying parameter model (FLS) and OLS formulation are substantially different. From our graphs of betas over time, one gains insight into the changing nature of risk and the impact of institutional and macroeconomic events. Systematic risk is shown to increase for most crops over the analyzed period with significant changes in volatility after the collapse of the Bretton Woods Accord.

 
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Live and Feeder Cattle Options Markets: Returns, Risk, and Volatility Forecasting
Lee Brittain, Philip Garcia, and Scott H. Irwin
Year: 2009
 

Abstract

The paper examines empirical returns from holding thirty- and ninety-day call and put positions, and the forecasting performance of implied volatility in the live and feeder cattle options markets. In both markets, implied volatility is an upwardly biased and inefficient predictor of realized volatility, with bias most prominent in live cattle. While significant returns exist holding several market positions, most strategies are strongly affected by a drift in futures market prices. However, the returns from selling live cattle puts are persistent, and evidence from straddle returns identifies that the market overprices volatility. This overpricing is consistent with a short-term risk premium whose effect is magnified by extreme changes in market conditions.

 
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Price Volatility, Nonlinearity and Asymmetric Adjustments in Corn, Soybean and Cattle Markets: Implication of Ethanol-driven Shocks
Hernan A. Tejeda and Barry K. Goodwin
Year: 2009
 

Abstract

Grain prices have risen sharply since 2005 and 2006 affecting livestock markets by increasing feed prices and leading to significant volatility shocks. The high price levels and magnitude of sustained high volatilities has raised concerns for many sectors of the economy, in particular those with direct relation to these markets. Policy makers are analyzing the interrelationships among these markets, and the effects of energy market shocks on agricultural markets. This study considers a threshold structure in a multivariate time-series model that evaluates these market linkages, capturing asymmetric correlations between grain and livestock prices, including volatility spillovers. We empirically study the impact of corn usage for ethanol production in the evolution of the above mentioned prices. Results are compared to previous scenarios where corn, soybean and livestock production and consumption did not face the corn demand for ethanol production. We find positive dynamic correlations between corn and soybean and feeder and fed cattle prices, consistent with the literature. And we find an inverse or negative relation between corn and feeder/calf prices for the period post mandated ethanol production, as anticipated by the literature for increased corn prices. Also, we find there are adjustment costs inhibiting price transmission between the crops and the live cattle market, in the form of modifying feeding rations. More relevantly, we identify plausible asymmetric effect on the correlations between the markets, especially when considering the period for the ethanol driven corn consumption versus previous periods of corn consumption. These asymmetric correlations are the result of spillover effects.

 
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Grain Futures Markets: What Have They Learned?
Joseph M. Santos
Year: 2009
 

Abstract

Taken together, studies that examine how well commodity futures markets perform find that risk premiums are common—and so unbiasedness is not—and markets are not uniformly efficient across commodities or forecast horizons. This large body of research sheds important light on whether and to what extent commodity-futures markets forecast optimally future spot prices and, so, enable commercials to manage price risk by effectively parsing out much of it to speculators, a process that improves the total welfare of an economy with competitive but otherwise-incomplete markets. Nevertheless, that speculators can, in effect, improve welfare in this way has done little to quell popular hostilities toward futures markets. Such hostilities—and, in particular, those directed at speculators—in North America date to the inception of these markets in the nineteenth century, and have contributed to the unflattering depiction of the early futures exchange as an inchoate and poorly managed institution that initially served only the (illegitimate) aspirations of gamblers, an original-sin creation narrative that surely compromises the legitimacy of modern futures markets. Unfortunately, economists’ understanding of early commodity-futures markets is particularly fragmented—the extant literature focuses almost exclusively on the post-World War II era—and, as such, claims regarding the performance of early futures markets remain largely unsubstantiated in any quantitatively measurable sense. In this paper, I test and compare the efficiency properties of wheat, corn, and oats futures prices on the Chicago Board of Trade (CBT) from 1880 to 1890 and from 1997 to 2007. I demonstrate that, on balance, these nascent nineteenth-century grain-futures markets were, like their contemporary counterparts in this case, mostly efficient. As such, these results support the claims of early proponents of futures markets who argued that the development of the futures exchange was shaped primarily by commercial interests who sought to mitigate price risk.

 
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The Effects of the Micro-Market Structure for Kansas Grain Elevators on Spatial Grain Price Differentials
Daniel M. O’Brien
Year: 2009
 

Abstract

Corn and wheat cash prices in Kansas are affected by a number of local supply-demand, market structure, transportation access and other factors. Kansas corn prices in 2008 were affected by form of business organization, local feedgrain production and livestock feed usage, elevator storage capacity, access to railroad grain handling facilities, and to a limited degree by the number of competitors in local markets. Geographic proximity to grain ethanol plants did not have a positive impact on local corn prices, although a number of mitigating factors may exist. Kansas wheat prices in 2008 were affected by local wheat production, elevator storage capacity, the number of competitors in local markets, and by location relative to flour mills. Evidence of operating cost and efficiency differences among grain elevators indicate the presence of market power in local Kansas grain markets.

 
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The Relative Performance of In-Sample and Out-of-Sample Hedging Effectiveness Indicators
Roger A. Dahlgran
Year: 2009
 

Abstract

Hedging effectiveness is the proportion of price risk removed through hedging. Empirical hedging studies typically estimate a set of risk minimizing hedge ratios, estimate the hedging effectiveness statistic, apply the estimated hedge ratios to a second group of data, and examine the robustness of the hedging strategy by comparing the hedging effectiveness for this "out-ofsample" period to the "in-sample" period. This study focuses on the statistical properties of the in-sample and out-of-sample hedging effectiveness estimators. Through mathematical and simulation analysis we determine the following: (a) the R2 for the hedge ratio regression will generally overstate the amount of price risk reduction that can be achieved by hedging, (b) the properly computed hedging effectiveness in the hedge ratio regression will also generally overstate the true amount of risk reduction that can be achieved, © hedging effectiveness estimated in the out-of-sample period will generally understate the true amount of risk reduction that can be achieved, (d) for equal numbers of observations, the overstatement in (b) is less that the understatement in ©, (e) both errors decline as more observations are used, and (f) the most accurate approach is to use all of the available data to estimate the hedge ratio and effectiveness and to not hold any data back for hedge strategy validation. If structural change in the hedge ratio model is suspected, tests for parameter equality have a better statistical foundation that do tests of hedging effectiveness equality.

 
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Revenue Risk Reduction Impacts of Crop Insurance in a Multi-Crop Framework
Joshua D. Woodard, Bruce J. Sherrick, and Gary D. Schnitkey
Year: 2009
 

Abstract

This study develops a multi-crop insurance model which is employed to evaluate crop insurance decisions when several crops are produced jointly. The results suggest that the diversification effects derived from producing multiple crops can substantially alter the risk reduction impacts of crop insurance versus if the decision is viewed from the perspective of a single crop. Further, the relatedness of crop production and price responses among crops differs considerably across insurance products and strategies. As a result, insurance strategies that might provide the maximum risk reduction for an individual crop do not necessarily carry over to the multi-crop case.

 
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Cotton Futures Dynamics: Structural Change, Index Traders and the Returns to Storage
Gabriel J. Power, and John R.C. Robinson
Year: 2009
 

Abstract

The commodity bull cycle of 2006-2008 and subsequent dramatic price decline have been a source of hardship for traditional commodity market participants such as producers and merchant/shippers. The usefulness of futures markets has been called into question, especially given that some market movements did not appear to be justified by economic fundamentals. An emerging research literature examines the possible influence of futures traders, and particularly the non-traditional Index Traders, on the well-functioning of futures markets and underlying commodity markets. Cotton is a relatively under-studied commodity that is of particular importance for producers in the South and Southwest. To this end, this paper asks the following questions: (1) What role have (primarily long-only) Index Traders played, if we simultaneously account for important ongoing changes in cotton economic fundamentals? (2) Have seasonal and long-run patterns of convenience yield and price volatility changed during or since the commodity bull cycle? (3) How well do the data support a theory of storage model using the concept of convenience yield, and has the relationship changed with the commodity bull cycle? The results presented in this paper suggest that traditional, well-established economic relationships for cotton futures markets clearly have been disrupted during the period 2006- 2009. However, we find no direct evidence to support the claim that Index Traders are responsible for changes in prices or volatility.

 
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Comparison of Hedging Cost with Other Variable Input Costs
John Michael Riley and John D. Anderson
Year: 2009
 

Abstract

Recent spikes in commodity prices have led to higher margin amounts and option premiums. For the most part, producers have always attributed their lack of use in reducing risk via futures and options markets to the high cost associated with the use of these markets. This study determines the relative costs of hedging with futures and options and compares these with the costs of other variable inputs. We find that with the exception of hedging corn with both tools and soybeans with options the costs of hedging has only increased at roughly the same rate as all other inputs.

 
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A Comparison of the Effectiveness of Using Futures, Options, LRP Insurance, or AGR-lite Insurance to Manage Risk for Cow-calf Producers
Dillon M. Feuz
Year: 2009
 

Abstract

A comparative analysis was performed looking at using cash, futures, options, or insurance to manage the price of calves for cow-calf producer. Risk can be reduced with the futures market and with options or LRP insurance. Options and LRP insurance are equivalent in the amount of risk that is reduced. AGR-Lite does not appear to be an effective policy at reducing risk for cow-calf producers.

 
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Liquidity Costs in Futures Options Markets
Samarth Shah, B. Wade Brorsen, and Kim B. Anderson
Year: 2009
 

Abstract

The major finding is that liquidity costs in futures options market are two to three times higher than liquidity costs in the futures market. Liquidity cost is one potential factor to consider when choosing between hedging with a futures contract or with an option contract. While there is considerable research that estimates liquidity costs of futures trading, there is little comparable research about options markets. This study, for the first time, attempts to determine and compare liquidity costs in options and futures markets. The study uses July 2007 wheat futures and options contracts traded on Kansas City Board of Trade. Two measures of liquidity costs were used for both options and futures markets. One measure of liquidity costs in options markets is the average bid-ask spread that is calculated from the available bidask quotes. A new measure of liquidity costs in options markets is derived based on the Black model and it uses trade prices instead of observed bid-ask quotes. The liquidity costs in the options market was estimated to be 1.60 cents per bushel using observed bid-ask spreads and it was 1.37 cents per bushel when the new measure was used. Liquidity costs in the futures markets are estimated using Roll’s measure and average absolute price changes. The estimates were 0.45 and 0.49 cents per bushel, respectively for futures contracts. A positive relation was found between option liquidity costs and moneyness of the option. Days to expiration of the contracts was not statistically significant in explaining the liquidity cost of the option.

 
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Optimal Length of Moving Average to Forecast Futures Basis
Robert B. Hatchett, B. Wade Brorsen, and Kim B. Anderson
Year: 2009
 

Abstract

Futures prices when combined with a basis forecast provide a reliable way to forecast cash prices. The most popular method of forecasting basis is historical moving averages. Given the recent failure of longer moving averages proposed by previous studies, this research reassesses past recommendations about the best length of moving average to use in forecasting basis. This research compares practical preharvest and storage period basis forecasts for hard wheat, soft wheat, corn and soybeans to identify the optimal amount of historical information to include in moving average forecasts. Only with preharvest hard wheat forecasts are the best moving averages longer than 3 years. The differences in forecast accuracy among the different moving averages are small and in most cases the differences are not statistically significant. The recommendation is to use longer moving averages during time periods (or at locations) when there have been no structural changes and use last year’s basis after it appears that a structural change has occurred.

 
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Commercial Grain Merchandisers: What Do They Need to Know?
Brandon Kliethermes, Joe Parcell, and Jason Franken
Year: 2009
 

Abstract

Little information exists on grain merchandisers, their characteristics, and the skills needed to be successful. This research contributes toward filling this gap. A summary of survey responses from 230 experienced grain merchandisers quantifies personal characteristics, skills perceived as important, and desire for executive education. Parametric analyses identify factors contributing to merchandisers’ salaries and their interest in establishing a certification process. Interestingly, experience but not formal education significantly enhances salaries.

 
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A Speculative Bubble in Commodity Futures Prices? Cross-Sectional Evidence
Dwight R. Sanders, Scott H. Irwin, and Robert P. Merrin
Year: 2009
 

Abstract

Recent accusations against speculators in general and long-only commodity index funds in particular, include: increasing market volatility, distorting historical price relationships, and fueling a rapid increase and decrease in commodity inflation. Some researchers have argued that these market participants—through their impact on market prices—may inadvertently prevented the efficient distribution of food aid to deserving groups. Certainly, this result—if substantiated— would counter the classical argument that speculators make prices more efficient and thus improve the economic efficiency of the agricultural and food marketing system. Given the very important policy implications, it is crucial to develop a more thorough understanding of long-only index funds and their potential market impact. Here, we review the criticisms (and rebuttals) levied against (and for) commodity index funds in recent U.S. Congressional testimonies. Then, additional empirical evidence is added regarding cross-sectional market returns and the relative levels of long-only index fund participation in 12 commodity futures markets. The results suggest that index fund positions across futures markets have no impact on relative price changes across those markets. The empirical results provide no evidence that long-only index funds impact commodity futures prices.

 
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A Limited Information Bayesian Forecasting Model of the Cattle SubSector
Babatunde Abidoye and John D. Lawrence
Year: 2009
 

Abstract

The first step towards forecasting the price and output of the cattle industry is understanding the dynamics of the livestock production process. This study follows up on the Weimar and Stillman (1990) paper by using data from 1970 to 2005 to estimate the parameters that characterizes the cattle output supply. The model is then used to estimate forecast values for the periods 2006 and 2007. Bayesian limited information likelihood method is used to estimate the parameters when endogeneity exists between these variables. The forecasting ability of the model for a twostep ahead forecast for majority of the variables are relatively good and test statistic of the forecast are reported.

 
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Do Composite Procedures Really Improve the Accuracy of Outlook Forecasts?
Evelyn V. Colino, Scott H. Irwin and Philip Garcia
Year: 2009
 

Abstract

This paper investigates whether the accuracy of outlook hog price forecasts can be improved using composite forecasts in an out-of-sample context. Price forecasts from four wellrecognized outlook programs are combined with futures-based forecasts, ARIMA, and unrestricted Vector Autoregressive (VAR) models. Quarterly data are available from 1975.I through 2007.IV, which allow for a relatively long out-of-sample evaluation period after permitting model specification and appropriate composite-weight training periods. Results show that futures and numerous composite procedures outperform outlook forecasts. At intermediate horizons, OLS composite procedures perform rather well. The superiority of futures and composite forecasts decreases at longer horizons except for an equal-weighted approach. Importantly, with just few exceptions, nothing outperforms the equal-weight approach significantly in any program or horizon. Overall, findings favor the usage of equal-weighted composites, a result that is consistent with previous empirical findings and recent theoretical papers.

 
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The Price Impact of Index Funds in Commodity Futures Markets: Evidence from the CFTC’s Daily Large Trader Reporting System
Nicole M. Aulerich, Scott H. Irwin, and Philip Garcia
Year: 2009
 

Abstract

This paper analyzes the price impact of long-only index funds in commodity futures markets for the January 2004 through July 2008 period. Daily positions of index traders in 12 markets are drawn from the internal large trader reporting system used by the CFTC. Granger causality test results provide negligible evidence that index traders impact commodity future returns regardless of the measure of market participation considered. The signs of the relatively few significant coefficients are as likely to be negative as positive and the magnitudes of the economic effects are very small. Some evidence is found that volatility has been influenced by the presence of index traders in several markets, but only using one of the measures of index position changes. These effects appear to be small in economic magnitude, except in several traditionally less liquid markets. While the overall balance between significant positive and negative signs is nearly equal, index positions appear to have had a dampening effect on volatility during 2004-2005 particularly in the soft commodity contracts, followed by a heightening effect during 2006-2008 in deferred contracts.

 
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