Hedging with commodity futures and options under alternative farm programs: A farm level analysis
Abstract
The purpose of this study is to determine how hedging with futures contracts and put options is affected by the financial characteristics of the farm and by government farm policies. The study focuses on the financial liquidity provided by hedging and how the value of this liquidity is reduced by farm programs. Farms with varying degrees of financial leverage are studied. The four policies examined are abolishing farm price supports (NOBILL), price supports through loan rates on corn and soybeans, a target price and loan program combined, and only a target price which is similar to a marketing loan. An econometric simulation model is used to generate corn and soybean price and yield distributions under the alternative farm programs. Each distribution is converted into discrete-probability states of nature which are used in a discrete stochastic programming model of a typical Midwest corn-soybean farm. The decision variables in the expected utility maximizing model include pre-harvest and post-harvest hedging with futures and options. Results of the study under the NOBILL policy indicate that liquidity is an important motivation for hedging. For high debt farmers with logarithmic utility, it was found optimal to purchase put options to cover 70.1 percent of expected corn production for pre-harvest hedging. The tight liquidity position of the high debt farm resulted in selling about two-thirds of the corn production at harvest. In the post-harvest period, the remaining one-third was hedged about half with put options. Similarly, about two-thirds of the soybeans were sold in the fall, and one-half the remaining third hedged in the post-harvest period with puts. No soybeans were hedged with pre-harvest contracts. In contrast, low debt farms used no pre-harvest hedges for corn or soybeans. Further, the low debt farmer hedges only a minor amount in the post-harvest period. Results for alternative policies suggest that farm policy provisions substitute partially, but not entirely, for hedging. Also, it was found that non-participating farmers should hedge more than participating farmers, but less than under the NOBILL policy. Finally, it was found that purchase of put options was generally preferred over short futures positions.
Degree
Ph.D.
Advisors
Baker, Purdue University.
Subject Area
Agricultural economics
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