Finding optimal price risk management instruments: the case of the Spanish potato sector

This article offers a comprehensive analysis of the problem of choosing between alternative market risk management instruments. We model farmers' behavior to optimize the certainty equivalent, formulated by a mean–variance model, by combining instruments with and without basis risk. Results are expressed as the demands for hedging with futures, forward contracts and insurance. Theoretical results are applied to a selection of Spanish producers of fresh potatoes, a sector that is exposed to significant market risks. Amsterdam's Euronext provides potato futures prices, and the recently launched revenue insurance in Spain provides the example for price insurance. Three conclusions summarize the article's main findings. First, we show that Spanish potato revenue insurance subsidies are a factor that determines the instrument rankings and choice. Second, the efficiency of insurance subsidies is generally low. Finally, the Amsterdam potato futures market does not provide a cost‐effective means to manage price risks for Spanish fresh potato growers.     

Measuring the functional efficiency of agricultural futures markets

This article presents a method for measuring the functional efficiency of agricultural futures markets in terms of social welfare using a standard futures market structural model. Employing the concept of social surplus, it can be shown that, when futures prices are used to estimate future spot prices, the errors in prediction produce to some degree resource misallocation, which in turn results in welfare losses. Therefore, the social welfare associated with the presence of futures markets can be measured using a Social Loss index. The indicator was calculated for the period 1975–2015 and for several subperiods, which allow us to analyse functional efficiency before and after the 2007–2008 spikes in the prices of agricultural commodities. Futures contracts for 12 products are evaluated. The products are grouped in three different categories: ‘soft products’, ‘livestock’ and ‘grains and oilseeds’. The results indicate that livestock contracts tended to be more efficient than the rest of the contracts during the whole period, but in 2008–2015 their efficiency decreased vis‐á‐vis the rest of the products. Nevertheless, 2008–2015 proved to be the most efficient subperiod, confirming the remarkable development of agricultural futures markets over time.     

The costs of global tariff barriers on wool products: 1997–2005

The Doha round of multilateral trade negotiations commits World Trade Organization (WTO) members to improving market access for both agricultural and nonagricultural goods. Tariff barriers on wool products represent a small but important subset of these negotiations. To inform the debate on the round, we analyze the distortionary effects of recent (1997–2005) tariff barriers on wool products using a model that applies a comprehensive analytical approach with regard to the production, trade, and consumption of wool products. We also account for any indirect effects of wool tariff barriers on the nonwool economy by incorporating the production, trade, and consumption of nonwool products, that is, the framework is a comparative‐static global general equilibrium model with a detailed representation of the world wool market. Changes in wool tariffs over 1997–2005 lead to positive welfare effects for most regions; Italy, China, and the UK are estimated to have gained the most from the changes. The results indicate that the nature of recent wool tariffs severely distort the size of wool industries in different regions. The changes in the output of wool commodities are extreme reflecting the discriminatory nature of the tariffs.     

Measuring price discovery between nearby and deferred contracts in storable and nonstorable commodity futures markets

Using price discovery measures, including Putniņš’ (2013) information leadership share and intraday data, we quantify the proportional contribution of nearby and deferred contracts in price discovery in the corn and live cattle futures markets. On average, nearby contracts reflect information more quickly than deferred contracts in the corn market, but have a relatively less dominant role in the live cattle market. In both markets, the nearby contract loses dominance when its relative volume share dips below 50%, which typically occurs when the nearby is close to maturity. Regression results indicate that the share of price discovery is mainly related to trading volume and time to expiration in both markets. In the corn market, price discovery share between nearby and deferred contracts is also related to inverse carrying charges, crop year differences, USDA announcements, market crashes, and commodity index position rolls. Differences between corn and live cattle markets are consistent with differences in the contracts’ liquidity and commodity storability.     

Feasibility of Trading International Futures Contracts for Shelled Peanuts

A survey of the world-wide peanut industry was conducted to investigate the feasibility of an international shelled peanut futures contract. The study finds that there is a substantial interest and favorable attitudes toward the futures markets and the proposed contract among the respondents. The potential trading volumes, based on the survey responses and international trade statistics, were estimated to fall between 113,745 and 562,645 contracts (20 metric tons per contract). The estimates were considered high enough to indicate a potential for successful introduction of the contract to a futures market.     

Finding default? Understanding the drivers of default on contracts with farmers’ organizations under the World Food Programme Purchase for progress pilot

During the past two decades, food assistance policy has shifted toward local or regional food purchases and away from purchases from donor countries. Although most local and regional procurement occurs through hard tendering processes open to large‐scale firms and farms, there is growing interest in identifying how and whether to procure from smallholder farmer organizations (FOs). To date, little is known about the drivers of successful contracting with FOs. We utilize data from the United Nations World Food Programme Purchase for Progress pilot in three East African countries to predict defaults on contracts. We examine four possible explanations: country contexts, FO characteristics, prior experience with contracts, and contract modalities and their relationship to local spot market prices. The single most important predictor of default is the increase in market prices between contract approval and delivery. Yet, although increases in market prices are linked to increases in default, this relationship is decreasing in contract size, indicating search costs associated with breaking contracts. Our findings yield both generalizable and context‐specific insights about whether—and when—procuring from smallholder farmers can be successfully integrated into the food assistance toolkit.     

Time‐varying Hedge Ratios: A Principal‐agent Approach

We use the classic agency model to derive a time‐varying optimal hedge ratio for low‐frequency time‐series data: the type of data used by crop farmers when deciding about production and about their hedging strategy. Rooted in the classic agency framework, the proposed hedge ratio reflects the context of both the crop farmer's decision and the crop farmer's contractual relationships in the marketing channel. An empirical illustration of the Dutch ware potato sector and its futures market in Amsterdam over the period 1971–2003 reveals that the time‐varying optimal hedge ratio decreased from 0.34 in 1971 to 0.24 in 2003. The hedging effectiveness, according to this ratio, is 39%. These estimates conform better with farmers’ interest in using futures contracts for hedging purposes than the much higher estimates obtained when price risk minimisation is the only objective considered.     

The role of input vouchers in modernizing the fresh fruit and vegetable market in Turkey

Contractual arrangements between farmers and traders aiming at providing input/credit in return for output selling have been widely studied in the literature on agricultural economics. Nonetheless, there is one issue, which is barely mentioned in the literature: how to enforce the contract terms when traders offer credit in cash rather than input advances? This article aims to describe an innovation in farming contracts, used by fresh fruit and vegetable wholesalers in Turkey, which involves a kind of private voucher system. Drawing on original data collected from wholesalers—a segment in the supply chain hardly covered in the literature—we investigate the factors determining contract adoption using a two‐limit Tobit model. Our results suggest that this private voucher system contributes to supply chain coordination and facilitates smallholder farmer participation in export and supermarket channels, which are growing rapidly in this developing country.     

More reasons why farmers have so little interest in futures markets

The use by farmers of futures contracts and other hedging instruments has been observed to be low in many situations, and this has sometimes seemed to be considered surprising or even mysterious. We propose that it is, in fact, readily understandable and consistent with rational decision making. Standard models of the decision about optimal hedging show that it is negatively related to basis risk, to quantity risk, and to transaction costs. Farmers who have less uncertainty about prices and those with a diversified portfolio of investments have lower optimal levels of hedging. If a farmer has optimistic price expectations relative to the futures market, the incentive to hedge can be greatly reduced. And finally, farmers who have low levels of risk aversion have little to gain from hedging in terms of risk reduction, in that the certainty‐equivalent payoff at their optimal hedge may be little different than the certainty equivalent under zero hedging. These reasons are additional to the argument of Simmons (2002) who showed that, if capital markets are efficient, farmers can manage their risk exposure through adjusting their leverage, obviating the need for hedging instruments.     

Comparative Advantage in Demand: Experimental Evidence of Preferences for Genetically Modified Food in the United States and European Union

The United States (US) exports more than US$6 billion in agricultural commodities to the European Union(EU) each year, but one issue carries the potential to diminish this trade: use of biotechnology in food production. The EU has adopted more stringent policies towards biotechnology than the US. Understanding differences in European and American policies towards genetically modified (GM) foods requires a greater understanding of consumers’ attitudes and preferences. This paper reports results from the first large‐scale, cross‐Atlantic study to analyse consumer demand for genetically modified food in a non‐hypothetical market environment. We strongly reject the frequent if convenient assumption in trade theory that consumer preferences are identical across countries: the median level of compensation demanded by English and French consumers to consume a GM food is found to be more than twice that in any of the US locations. Results have important implications for trade theory, which typically focuses on differences in specialization, comparative advantage and factor endowments across countries, and for on‐going trade disputes at the World Trade Organization.     

A speculative bubble in commodity futures prices? Cross‐sectional evidence

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 the level of commodity prices. Some researchers have argued that these market participants—through their impact on market prices—may have 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 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 empirical results provide scant evidence that long-only index funds impact returns across commodity futures markets.     

Exporting to new destinations and the effects of tariffs: the case of meat commodities

This study uses a random parameter probit estimation to examine the effects of tariff liberalization on the probability of establishing new trading relationships in meat commodities. Our simulation results indicate that the effects of tariff reductions decrease with distance, but increase with the level of development. The probabilities of trade increase at an increasing rate with the size of tariff reductions thus justifying calls for ambitious liberalization schemes. Canada and Mexico are the NAFTA countries that are most likely to export in response to EU tariff reductions on bovine and poultry meats, while Brazil and Argentina emerge as the MERCOSUR countries most likely to penetrate the EU bovine meat market after EU tariff reductions. Uruguay's probability to export poultry meat is most responsive to EU tariff reductions.     

Insights from Anticipatory Prices

Contemporaneous observations on expected supply and on prices of post‐harvest futures contracts for corn are used to estimate expected demand relationships. These equations are used to estimate the prices of the post‐harvest contracts based on new supply estimates. Each estimate can be compared with a corresponding futures price, i.e. the market forecast. The differences help discern the market expectations about the expected demand for the new crop relative to historical experience, which can help support outlook analyses. We find that in recent years, a 100 million bushel change in the expected supply of corn results in about a 6 cent per bushel negative change in the price of December corn. The discussion also deepens understanding of the term ‘anticipatory prices’ as defined by Holbrook Working in his 1958 work.     

A hedonic approach to estimating the supply of variety attributes of a subsistence crop

The article extends the household hedonic model by estimating a supply function for variety attributes of a subsistence crop in a developing economy. The model is applied to bananas in Uganda, making use of disaggregated data on variety‐specific farm‐gate banana bunch prices and attributes, while accounting for the semisubsistence nature of banana‐producing households. The article is motivated by the need to understand the attribute trade‐offs made by farmers at the farm gate in light of targeted variety improvement efforts and their impact on banana markets. Whether variety improvement will pay off at the market level requires a more detailed examination of the relative worth of banana attributes within the structure of consumer preferences and production technologies related to bananas in Uganda. The results confirm the importance of consumption and production attributes in selling behavior. Quality and bunch size are found to be complements at the farm gate. Banana bunches that capture a premium at the market will be those that provide bundles of desirable consumption and production attributes simultaneously. By revealing important price–attribute relationships, the findings provide guidance for crop improvement efforts and diversification choices, while taking into account implicit market signals for output attributes.     

Contract farming and smallholder incentives to produce high quality: experimental evidence from the Vietnamese dairy sector

In emerging markets for high‐value food products in developing countries, processing companies search for efficient ways to source raw material of high quality. One widely embraced approach is contract farming. But relatively little is known about the appropriate design of financial incentives in a small farm context. We use the example of the Vietnamese dairy sector to analyze the effectiveness of existing contracts between a processor and smallholder farmers in terms of incentivizing the production of high quality milk. A framed field experiment is conducted to evaluate the impact of two incentive instruments, a price penalty for low quality and a bonus for consistent high quality milk, on farmers’ investment in quality‐improving inputs. Statistical analysis suggests that the penalty drives farmers into higher input use, resulting in better output quality. The bonus payment generates even higher quality milk. We also find that input choice levels depend on farmers’ socio‐economic characteristics such as wealth, while individual risk preferences seem to be less important. Implications for the design of contracts with smallholders are discussed.     

Spillovers from high-value agriculture for exports on land use in developing countries: evidence from Madagascar

High-value agriculture for exports is increasingly important in developing countries. In a case study of contract farming for exports of vegetables from Madagascar, strong spillover effects of these trade opportunities on land use are found to exist. Using a matched plot sampling design, the productivity of rice—the main domestically consumed staple—is shown to be two-thirds higher on fields that were contracted during the off-season for the production of vegetables. This increase in yields is linked to an increase of soil fertility due to the application of fertilizer and compost, which farmers did not use prior to the contracts. Although agricultural output goes up significantly, labor productivity stays the same, suggesting that there is greater labor absorption on existing land and the diffusion of this type of technology at a larger scale throughout Madagascar would be expected to substantially decrease incentives to deforest by increasing wages and to boost productivity of existing lands relative to newly deforested ones.     

Competition between farmed and wild salmon: the Japanese salmon market

This article examines the Japanese market for salmon. This market is of interest, since it is the largest and most diversified salmon market in the world with wild and farmed species, from Europe and South and North America, competing in the same market. In contrast to the European Union (EU)‐ and U.S.‐markets, there have been neither trade conflicts nor trade restrictions. The Japanese market can hence provide information about the impact of bringing substantial quantities of a new product into a market, and the effect of large‐scale aquaculture on traditional fisheries. In this article, market integration between wild and farmed salmon on the Japanese market is examined, using both bivariate and multivariate cointegration analysis. Tests for the Law of One Price are also conducted. The results indicate that the species are close substitutes on the market, and that the expansion of farmed salmon has resulted in price decreases for all salmon species.     

What Killed the Diammonium Phosphate Futures Contract?

Using a survey of industry participants, and an analysis of price relationships, this paper investigates the demise of the diammonium phosphate futures. The results indicate the diammonium phosphate cash and futures markets were not well linked. The results also suggest that the initial specifications of diammonium phosphate futures contract may have resulted in its use as a forward contract with a high rate of delivery, reducing market participation and limiting liquidity. Ultimately, the contract failed because it was a poor hedging tool, and was perceived by the industry not to offer benefits beyond existing contracting and risk management practices.     

Agricultural trade liberalization and economic development: the role of downstream market power

A model is developed to characterize the vertically linked and concentrated nature of developed‐country food markets. This model is then parameterized and used to simulate the effects of varying food market structures on the benefits to developing‐country exporters of agricultural commodities from trade liberalization by developed countries. Results demonstrate that even relatively modest departures from perfect competition can cause much of the benefits from trade liberalization to flow to marketing firms instead of producers in the developing country. The distributional effects under downstream market power differ significantly from the perfectly competitive case and may result, somewhat paradoxically, in developing countries receiving a lower share of the total value added within the food chain as trade reform occurs.     

Heterogeneous Risk Preferences,Discount Rates and Land Contract Choice in Ethiopia

This paper analyses the role of risk and rate of time preference in the choice of land contracts. The analysis builds on the risk‐sharing and imperfect market explanations of contract choice. Unique data from Ethiopia, which contain land contract information and experimental risk and rate of time preference measures on matched landlord–tenant partners, are employed in the empirical analysis. The results show that landlord and tenant time preferences are significant determinants of contract choice. For landlords (but not tenants), risk preference is also significant, indicating the importance of financial constraints and production risk in the determination of contract choice. The results are of particular relevance to land market policy in Ethiopia, where production is risk‐prone, financial markets are imperfect, and where there is a major need for the development of vibrant land rental markets.