An Examination of Farm Sector Real Asset Dynamics: 1910–85

Abstract

The dynamic response of real farm asset values to changes in net returns and interest rates is studied using vector autoregression. Results show that a shock in real asset values, real returns to assets, or real interest rates leads to a process in which real asset values overreact. In the initial period, a reaction to a shock immediately occurs followed by a continued build-up in the asset value for up to six years until finally the effect of the one-time, transitory shock begins to die out. The results suggest a market with a propensity for bubbles.The propensity for periodic long-term swings in the value of farm assets has been an important, almost inherent, characteristic of the agricultural sector. Melichar (1984a) points to two boom-bust periods earlier in this century and to two in the nineteenth century. The effects of these extended over several decades, and each shaped the fortunes of a generation of farmers, landlords, suppliers, and lenders. One of the important questions stemming from this history is whether the boom-bust sequence is the result of a rational dynamic response to the information available or a process of over-and under-shooting of asset values.This article reports the results from a study of the dynamic response of real farm asset values to changes in net returns and interest rates. Of particular interest is the hypothesis that there is no overreaction in the farm asset market. This study differs from previous studies through its emphasis on asset value dynamics and in the length of its data series. The relative importance of returns and interest Allen M. , and two anonymous referees. rates in determining asset values is also quantified. Furthermore, this study compares the determinants of asset value declines in the 1980s to those during the 1930s depression. The article is organized into five sections that include the following: a brief review of previous research on farm asset values, a description of the conceptual framework for understanding asset price dynamics and the vector autoregression (VAR) model, a discussion of the data, and the estimated results and analysis of the dynamics of real asset values. Review of Previous ResearchPast research on farm asset values has focused on land. Several explanations for the level of farmland values have been generated. Work in the 1960s was based on structural simultaneous equation models of supply and demand for land. Reynolds and Timmons concluded that expected capital gains, government payments for land diversion, conservation payments, farm enlargement, and the return on common stock were important variables in explaining land prices. Tweeten and Martin concluded that the major determinants of changes in farmland prices include pressures for farm expansion and capitalized benefits from government programs tied to land. Herdt and Cochrane concluded that technological progress and government supported output prices have influenced farmland prices. Klinefelter explained movements in land price using

Fads Versus Fundamentals In Farmland Prices

“…This data set is appealing because of its length and the homogeneity of the asset being The six-month commercial paper rate is used to measure the nominal interest rate. Featherstone and Baker (1987) and Hanson and Myers (1995) also used the commercial paper rate to measure the discount rate. Falk (1992) The data series pt, dt, and rt were transformed into"" the series Adt, Adt^rt, and St ( = Pt -dt) and then fit to a second-order VAR.…”

“…Burt (1986) concludes that deviations of farmland price from its fundamental path can be explained in terms of overreaction to rent movements. Featherstone and Baker (1987), on the other hand, conclude that these deviations are largely determined by purely speculative forces, i.e., by fads. No one, however, has attempted to quantify the fad component to help resolve this basic issue.…”

“…See, for example, Burt (1986), Featherstone and Baker (1987), Falk (1991, and Hanson and Meyers (1995). Although the specific methods and data sets differ across these papers, each one formally or informally rejects the present value model as an explanation of farmland prices.…”

“…See, for exatrple, Burt (1986), Featherstone andBaker (1987), Falk (1991Falk ( ,1992, and Hanson and Meyers (1995).…”

“…In this respect. the paper is closely related to Featherstone and Baker (1987) . They applied innovation accounting and impulse response analysis to an unrestricted VAR representation of price, rent, and the discount rate, under the assumption that these series are trend stationary.…”