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Are New Crop Futures and Option Prices for Corn and Soybeans Biased? An Updated Appraisal
Katie King and Carl Zulauf
Year: 2010
 

Abstract

This study revisits the debate over whether a bias exists in new crop December corn and November soybean futures and option prices. Some evidence of bias is found in December corn futures and December corn puts, but the evidence is substantially muted when transaction costs are included. The study also examines if information contained in the widely-followed World Agriculture Supply and Demand Reports (WASDE) issued by the U.S. Department of Agriculture as well as the implied volatility from new crop corn and soybean options are incorporated efficiently into December corn and November soybean futures prices. Previous studies have examined the immediate incorporation of public information into futures prices. This study examines whether public information is incorporated efficiently from the perspective of the change in price between the first non-limit close following the release of a WASDE report and the first contract delivery day. The May WASDE is the first release of the calendar year to include estimates of the forthcoming new crop year’s supply and demand. For both the December corn and November soybean regressions, the intercept, change in stocks-to-use ratio between the current and new crop year reported in the May WASDE, and option market implied volatility are significantly different than zero at the 95 percent confidence level. The current crop year’s stocks-to-use ratio is not statistically significant. These results held in general for both the May and June WASDE releases, although some sensitivity occurred when the May WASDE observation period was divided in half and for the June WASDE. All variables were statistically insignificant at the July and August WASDEs. These results are not consistent with market efficiency until the July WASDE is released. However, because only 24 observations exist, these results fall more into the category of something that needs to be monitored in the future rather than as a direct confrontation to the theory of market efficiency.

 
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Pre-Spreading and Returns to Storage
Andrew McKenzie and Amanda Simpson
Year: 2010
 

Abstract

Returns to storage at the farm level have received much attention in the literature. The main objective of this paper was to analyze returns to storage at the elevator or merchandising level. Specifically basis trading and pre-spreading marketing strategies are empirically evaluated with respect to an October- March storage period in North Central Illinois corn. Results indicate that basis trading strategy is able to enhance returns to storage and reduce the risk associated with storing grain. Although pre-spreading strategy results in higher returns to storage for some years, there is no systematic evidence that pre-spreading can enhance returns or reduce risk above and beyond a simple basis trading strategy.

 
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Examining the Risk-Return Relationship between Agribusiness Stocks and the Market
Jerey H. Dorfman and Myung D. Park
Year: 2010
 

Abstract

Volatility and the trade-off between risk and returns have been considered key components of finance theory at least since Merton's intertemporal capital asset pricing model (ICAPM, 1973). In this study, we employ several bivariate GARCH-M models to investigate Merton's ICAPM for agribusiness industries and examine the best speci cation to use in estimating the relationship of asset returns in these industries with the broader market. The expected positive relation between stock return and its risk holds for both industries and we found a high posterior probability of a positive tradeo for the agricultural production portfolio.

 
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RIN Risks: Using Supply and Demand Behavior to Assess Risk in the Markets for Renewable Identification Numbers used for Renewable Fuel Standard Compliance
Dustin J. Donahue, Seth Meyer, and Wyatt Thompson
Year: 2010
 

Abstract

Congress has mandated that more biofuels be used over the next decade. To ensure compliance with the mandate, RINs are used to track biofuels that fuel blenders mix into motor fuels for domestic consumption. RINs may be traded, and the prices of RINs are affected by the ability of blenders and biofuel producers to comply with the mandate. There are four components to the mandate, one of which relates specifically to cellulosic biofuels, and the EPA has the authority to waive any or all components of the mandate. The purpose of this paper is to gain insight into the interactions between cellulosic biofuel technology and the mandate. To achieve this, the prices of RINs are simulated through the use of an economic model under scenarios varying both levels of technology and the enforcement or waiver of the cellulosic component. If the non-cellulosic components of the mandate are not waived, RIN markets are found to contain the effects that might otherwise be transmitted to crops markets. Higher levels of cellulosic biofuel technology are found to increase compliance costs in the presence of a mandate waiver but lower compliance costs if the mandate is not waived.

 
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The Impact of Biofuel Mandates and Switchgrass Production on Hay Markets
Kwame Acheampong, Michael R. Dicks, and Brian D. Adam
Year: 2010
 

Abstract

The Renewable Fuel Standard mandates in the Energy Independence and Security Act of 2007 (EISA 2007) will require 36 billion gallons of ethanol to be produced in 2022, 16 billion gallons of which is to be produced from cellulosic feedstocks. To meet the mandate, it is estimated that 24.7 million acres would be used to produce 109 million tons of switchgrass in 2025. Since the majority of these acres likely would be converted from land currently producing hay, cattle production will be reduced. As a step toward understanding the impacts of biofuel mandates on cattle markets, a linkage between hay production and hay prices needs to be established. For lower quality hay, the results indicate that a 10% decrease in Oklahoma production led to a 5% increase in Oklahoma price. For all hay, including higher quality alfalfa hay, the price increase was only 2% because of the large effect of Texas hay production.

 
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Forecasting Agricultural Commodity Prices Using Multivariate Bayesian Machine Learning Regression
Andres M. Ticlavilca, Dillon M. Feuz, and Mac McKee
Year: 2010
 

Abstract

The purpose of this paper is to perform multiple predictions for agricultural commodity prices (one, two and three month periods ahead). In order to obtain multiple-time-ahead predictions, this paper applies the Multivariate Relevance Vector Machine (MVRVM) that is based on a Bayesian learning machine approach for regression. The performance of the MVRVM model is compared with the performance of another multiple output model such as Artificial Neural Network (ANN). Bootstrapping methodology is applied to analyze robustness of the MVRVM and ANN.

 
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Ethanol Futures: Thin but Effective? —Why?
Roger A. Dahlgran
Year: 2010
 

Abstract

This study examines the paradox where the ethanol futures market provides effective hypothetical hedges yet the use of this market is shunned by those with ethanol cash market positions because of its limited volume and open interest. Examining this issue requires describing ethanol cash, futures, and swaps markets, and ethanol contracting practices. We observe that ethanol futures open interest is about two percent of annual U.S. usage compared to nine percent in gasoline markets. We also observe that an attempt by a single refiner to fully hedge its production would significantly alter the volume/open interest profile of the ethanol futures market. In this respect, the ethanol futures market is thin. The ethanol futures market is nonetheless efficient except in the final month of a contract’s life. We examine causality relationships between the ethanol futures and swaps markets and find that the futures market adjusts to swaps market disequilibrium but the converse does not hold. The implications of these findings are (1) because futures equilibrium open interest adjusts to changes in swaps equilibrium open interest, the futures price reflects conditions in the deeper swaps market as well as in the futures market, (2) because of (1) using the futures settlement price for marking swaps to market provides secure bonding in the over-the-counter ethanol derivatives (swaps) market, and (3) inefficiencies in the futures market during the last month of a contract’s life are likely due to the swaps market’s use of the cumulative average of the futures prices during the last month of the swap contract’s life.

 
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Producers’ Grain Marketing Decisions: A Study in the Canadian Markets
Stefanie Fryza and Fabio Mattos
Year: 2010
 

Abstract

This paper investigates the dynamics in the decision-making process of producers in Western Canada, where they must market their crop through the Canadian Wheat Board(CWB). The CWB offers several marketing alternatives to producers, which provide distinct combinations of return, risk, and cash flow. Pool pricing is the default alternative in which the CWB markets the grain for producers, while Producer Payment Options (PPO) represent instruments that producers can use to price their grain by themselves through the CWB. Preliminary analysis of 13,335 producers suggests that there is great heterogeneity in individuals marketing behaviour and that almost all producers who use PPO contracts deliver part of their crop to the pool accounts. This suggests that pool pricing is still largely used as the main marketing alternative, although producers seem to respond to price signals provided by the CWB and futures markets. Additionally, no clear evidence that producers who use PPO contracts are able to consistently outperform the pool was found. There also appears to be no direct relationship between PPO usage and pricing performance, implying that the adoption of PPO contracts appears not to be related to better or worse marketing performance. However, this point still needs further investigation with the complete data set and estimation of the regression models adopted in this study.

 
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Do USDA Announcements Affect the Correlations Across Commodity Futures Returns?
Berna Karali and ChangKeun Park
Year: 2010
 

Abstract

The value of USDA reports has long been a question of interest for researchers and practitioners. Many economists have investigated whether the scheduled public report releases have any impact on commodity prices. In general, it is shown that markets are e±cient; that is, prices move only when the reports contain \news". However, the impact of announcements on the correlations among related commodity prices has not been explored outside of ¯nancial asset markets. The purpose of this study is to simul- taneously measure the impact of selected USDA reports on the conditional variances and covariances of returns on related commodity futures contracts using a bivariate GARCH model. It is shown that several of the reports considered contain new informa- tion for the market participants as futures return volatilities and correlations between the returns are found to move on announcement days. The largest movements in return volatilities are observed on days with Grain Stocks, Hogs and Pigs, Livestock, Dairy, and Poultry Outlook, and WASDE releases.

 
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Reexamination of the Impact of the Removal of CBOT Corn and Soybean Futures Contract Delivery from Toledo, Ohio
Daniel Sanders, Matthew Roberts, and Carl Zulauf
Year: 2010
 

Abstract

Beginning with delivery on the July 2006 contract, non-convergence became an issue in the Chicago wheat futures contract. Despite several changes to the contract, convergence remains an issue. Recently, some have proposed eliminating Toledo, Ohio as a delivery point for the Chicago wheat contract. One concern is the potential impact this proposal could have on the cash-futures basis in the Toledo and surrounding delivery areas. To examine this issue, the impact of the removal of Toledo as a delivery point for corn and soybeans futures contracts beginning with contracts expiring in 2000 is examined. The changes in the Toledo and other Ohio corn and soybean basis conflict both in direction and significance, by crop and relative to changes in the corn and soybean basis in Illinois and Iowa. Thus, no consistent empirical evidence is found to support the claim that eliminating the Toledo switching district in 2000 as a delivery point for corn and soybeans had a serious detrimental effect on the corn and soybean basis in Ohio. These findings suggest that replacing Toledo as the primary delivery point for the Chicago wheat contract would not be expected to have a substantially negative impact upon the Ohio wheat basis.

 
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Measuring and Explaining Skewness in Pricing Distributions Implied from Livestock Options
Michael Thomsen and Andrew McKenzie
Year: 2010
 

Abstract

We characterize volatility skews implied by options on futures for hogs and cattle. Both markets have shown a persistent leftward skew. The skew is much more pronounced in live cattle. As a practical matter, the volatility skew is evidence that the cost of using options to insure against large price declines has been considerably more expensive than the cost of using options to insure against similarly large price increases. Out-of-the-money put options are expensive in livestock markets and this is especially the case for out-of-the-money put options on cattle futures. We also examine the relationship between the volatility skew and the ex ante physical returns distribution. We do this by measuring volatility skews just before releases of USDA reports and determine whether they can be empirically linked to the direction of the large price changes that often result. Some responses in live/lean hog futures prices could be explained by characteristics of the pre-report volatility skew. However, there was little evidence linking the volatility skew to post-report responses in live cattle futures.

 
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The Basis Effects of Failures to Converge
Berna Karali, Kevin McNew, and Walter Thurman
Year: 2010
 

Abstract

We study the spatial patterns to wheat basis (spot price minus futures price) for wheat contracts between 2005 and 2009. Restricting our attention to a single delivery market—Toledo, Ohio— and to cash markets within 100 miles of Toledo, we measure the co-movement of basis at inland markets with basis at Toledo. We examine the degree to which that co-movement is disrupted for contracts that failed to converge at delivery time.

 
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Comparing Different Models to Cross Hedge Distillers Grains in Iowa: Is It Necessary to Include Energy Derivatives?
Juan M. Murguia and John D. Lawrence
Year: 2010
 

Abstract

The actual and expected increase of corn based ethanol production in the Midwest has increased the availability of Distillers Grains that are used in the feeding and egg industry as source of protein and energy. Since no future market has existed for this product, no previous studies have found significant results for Iowa and no geographical market integration has been found, the use of corn, soybean meal (SBM) and energy futures contracts is analyzed to hedge Distillers Grains prices in Iowa. Alternative models are estimated and evaluated. Results indicate that there are potential opportunities for cross hedging DDG (Distillers Dried Grain) in Iowa using corn, SBM and energy futures that effectively decrease price risk up to 86% for a 13 week hedge.

 
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Price Mean Reversion and Seasonality in Agricultural Commodity Markets
Na Jin, Sergio Lence, Chad Hart, and Dermot Hayes
Year: 2010
 

Abstract

Schwartz's (1997) two-factor model is generalized to allow for mean reversion in spot prices. Our modeling also acknowledges that commodities exhibit seasonality patterns in the spot price. A Bayesian MCMC algo- rithm is developed to estimate our model. Estimation of the Schwartz model is done by imposing appropriate restrictions to our model. Estimation results are obtained based on monthly observations of soybean futures prices and options prices from the Chicago Board of Trade over period from January 1978 to January 2010. We empirically estimate and compare our model with the Schwartz model, and show how the assumption of mean reversion in spot prices and seasonality a ect the prediction of futures prices and option premium with short and long times to maturity.

 
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A Comparison of Hedging Strategies and Effectiveness for Storable and Non-Storable Commodities
Janelle Mann and Peter Sephton
Year: 2010
 

Abstract

This research questions whether the hedging potential of a futures market differs between storable and non-storable commodities. The relationship between asset storability and hedging effectiveness was examined using five years of daily cash and futures data for eight commodities. Three hedge ratios were estimated for each commodity – the naive (1:1) hedge ratio, the OLS hedge ratio, and either the BEKK-GARCH hedge ratios or the ECM-GARCH hedge ratios depending on whether or not the cash and futures price series were cointegrated. Results indicate that the futures market for livestock performed poorly in its hedging function compared to the futures market for other commodities; however, there was insufficient evidence to conclude that this holds for all non-storable commodities.

 
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Impact of Mandatory Price Reporting on Hog Market Integration
Jason Franken, Joe Parcell, and Glynn Tonsor
Year: 2010
 

Abstract

We examine whether mandatory price reporting (MPR), which is intended to facilitate transparent pricing, has impacted pricing relationships among U.S. hog markets. Hog markets are cointegrated both prior to and following enactment of MPR, but are not fully integrated in either period. That is, prices at alternative locations do not adjust one-for-one with price changes in other locations. Further, markets adjust to price shocks in other locations more slowly following MPR, which may be a coincidence associated with decreases in the proportion of spot market hog transactions.

 
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How Strong are the Linkages among Agricultural, Oil, and Exchange Rate Markets?
Julieta Frank and Philip Garcia
Year: 2010
 

Abstract

Highly fluctuating agricultural prices have rekindled questions regarding the influence of volatile oil and exchange rates markets on dynamic behavior. Using weekly cash data from 1998 to 2009 and VAR and VECM procedures, we estimate the linkages among several agricultural grain and livestock commodities, oil, and exchange rates. We identify a structural break in mid 2006, and perform the analysis for each period. In the first period, agricultural commodity prices are most influenced by idiosyncratic factors as reflected in own lagged prices, and exchange rates and crude oil have limited effect on agricultural markets. In the second period the effect of own lags in the agricultural markets are smaller and the effect of the exchange rate and crude oil are more pronounced, especially in the corn market. In recent years, agricultural commodity markets appear more dependent on exchange rates and to a lesser extent on oil prices.

 
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Price Discovery and Convergence of Futures and Cash Prices
Gerald Plato and Linwood Hoffman
Year: 2010
 

Abstract

Prices for corn, soybeans, and wheat futures contracts traded on the Chicago Mercantile Exchange and corresponding cash prices at delivery locations frequently failed to converge to the per bushel cost of delivering on futures contracts from 2000 to 2009. We found that convergence failure did not adversely effect the incorporation of market fundamentals from unanticipated information. Essentially identical mark fundamentals, from unanticipated information was incorporated into futures and cash prices when convergence failed. Futures and cash prices moved closer together as contract maturity approached even when they did not converge all the way to the per bushel contract delivery cost, indicating that arbitrage was occurring between the two prices but not completed. Without arbitrage the prices would most likely not incorporate identical market fundamentals from unanticipated information when convergence failed. Our results indicate that the failure to complete the arbitrage between futures and cash prices by driving the difference between them down to per bushel delivery cost at contact maturity affected the ability of the two prices to reflect identical market fundamentals.

 
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On the Relationship of Expected Supply and Demand to Futures Prices
Hans Walter P. Chua and William G. Tomek
Year: 2010
 

Abstract

Expectations about future economic conditions are important determinants of commodity prices. This paper presents a relatively simple model that makes futures prices for corn a function of expected production and inventories and of variables that account for demand shifts. The intent is to provide an historical, objective context for new price and quantity observations, which may help market analysts.

 
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The Forward Contract’s Income Shifting Option and Implications on the Forward Basis
Mindy L. Mallory and Scott H. Irwin
Year: 2010
 

Abstract

Previous studies have documented a cost of forward contracting grain relative to hedging in the futures markets. Our study quantifies the value of the income shifting option to forward contracting. An income shifting option refers to the fact that at harvest-time, a farmer can chose to sell uncontracted bushels of corn in the spot market or forward contract to sell after the first of the year. This option has non-trivial tax implications under a progressive tax system. By shifting income to the next tax year, a farmer can reduce the current year’s income level and avoid a higher marginal income tax rate. Further, if country elevators have market power, they can capture some of the value of this income shifting option by offering a weak forward delivery January basis bid. In a sufficiently captive draw area, an elevator knows that a farmer will be willing to accept a weak January forward basis bid so long as he still receives some income tax benefits from deferring sales to the next tax year.

This option is most valuable during years when farmer income is high. Therefore, in this study we posited that during years of high farmer income we would see forward basis bids which are abnormally lower and appreciate at a slower rate than the harvest-time immediate delivery bids. We measure this effect using basis bids from elevators in seven regions in Illinois from 1980 to 2009. We find that a 1% increase in yield above trend level decreases the January delivery forward basis bids by 3 cents per bushel; we also find that the January delivery forward basis bids appreciate at 44% the rate of the immediate harvest-time delivery basis bids.

 
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The Long Run and Short Run Impact of Captive Supplies on the Spot Market Price: An Agent-Based Artificial Market
Tong Zhang and B. Wade Brorsen
Year: 2010
 

Abstract

This paper seeks to reduce the gap between theoretical research that shows a potentially large price-depressing effect of captive supplies and empirical work that finds any pricedepressing effect of captive supplies is small. An agent-based model is developed that matches the results of Xia and Sexton (2004) as well as our generalization of their model. We relax Xia and Sexton’s (2004) assumption of no supply response by captive feeders, which reduces the price depressing effect of captive supplies. Finally, the agent-based model is used to simulate packers choosing both captive supply quantities and spot market quantities. Packers in the relaxed agent-based model choose no captive supplies and thus reach the Cournot solution. The research narrows the gap between theoretical models and the empirical work on captive supplies that shows little effect on prices, but a gap remains.

 
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Uncovering Dominant-Satellite Relationships in the U.S. Soybean Basis: A Spatio-Temporal Analysis
Daniel A. Lewis, Todd H. Kuethe, Mark R. Manfredo, and Dwight R. Sanders
Year: 2010
 

Abstract

Time series analysis shows that local soybean basis levels have some tendency to follow or be determined by the basis levels at export locations (Toledo and U.S. Gulf). Processing centers tend to show the most independence in basis discovery. Spatial modeling shows that each local basis produces a "spillover" and impacts neighboring basis levels. The spatial linkages are greatest during the spring and tend to be the lowest during fall. The results suggest that soybean basis discovery may be concentrated at export locations within the U.S. marketing system. Moreover, these dominant-satellite relationships are strongest during the spring season. Market practitioners may utilize this information when forming expectations for basis levels during the marketing year.

 
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Theory of Storage and Option Pricing: Analyzing Determinants of Implied Skewness and Implied Kurtosis
Marin Bozic and T. Randall Fortenbery
Year: 2010
 

Abstract

Options on agricultural futures are popular financial instruments used for agricultural price risk management and to speculate on future price movements. Poor performance of Black’s classical option pricing model has stimulated many researchers to introduce pricing models that are more consistent with observed option premiums. However, most models are motivated solely from the standpoint of the time series properties of futures prices and need for improvements in forecasting and hedging performance. In this paper we propose a novel arbitrage pricing model motivated from the economic theory of optimal storage. We introduce a pricing model for options on futures based on a Generalized Lambda Distribution (GLD) that allows greater flexibility in higher moments of the expected terminal distribution of futures price. We show how to use high-frequency data to estimate implied skewness and kurtosis parameters. We propose an economic explanation for variations in skewness based on the theory of storage. We use times and sales data for corn futures and options on futures for the period 1995-2009. After controlling for changes in planned acreage, we find a statistically significant negative relationships between ending stocks-to-use and implied skewness and kurtosis, as predicted by the theory of storage.

 
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Returns to Traders and Existence of a Risk Premium in Agricultural Futures Markets
Nicole M. Aulerich, Scott H. Irwin, and Philip Garcia
Year: 2010
 

Abstract

This paper analyzes the existence of a risk premium following the Keynesian theory of normal backwardation. A natural experiment using actual trading observations of commodity index traders is used to determine if passively holding long positions opposite hedgers earns a risk premium. Daily profits of traders are calculated in 12 markets from 2000-2009 using data from the CFTC internal large trader reporting system. Results show the commodity index traders have negative profits in 9 out of 12 commodities, resulting in an approximate net loss of -$6.9 billion. A measure of monthly return on investment does not show consistent positive profits and on average the return is negative. The evidence does not support the existence of a positive risk premium.

 
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