Robust live hog pricing strategies under uncertain prices and risk preferences

Abstract

roducers of agricultural commodities are faced with numerous and complex pricing P decisions. The number of pricing alternatives has been greatly expanded with the introduction of options on agricultural futures. The choice of appropriate marketing strategies is further complicated by the uncertain and changing nature of agricultural prices and differences in producers' risk preferences. The best pricing alternative is often sensitive to the producer's expectation of prices and preference for risk.In this context, it is useful to consider the "robustness" of alternative marketing strategies to the changing distribution of ending prices and to the level of risk that producers are willing to accept. Identifying strategies which provide favorable returns over a range of final distributions of cash and futures prices across different risk preferences can provide producers simpler, more effective marketing alternatives. Similarly, it may permit insight into the development of more general producer marketing strategies that will be effective even under changing market conditions [Babb et al. (1985)l.The objective of this article is to determine the importance of producer price expectations and risk preferences in selecting optimal marketing strategies, and to identify strategies that are relatively robust to differences in producer's attitudes toward risk and expectations about prices. Using a two-period simulation model with parameters appropriate for a hog producer, the choice of marketing strategies is analyzed. Changes in ex ante utility are used to assess the sensitivity of marketing strategies to different scenarios of the distribution of prices and to producer risk preferences.An emphasis of the analysis is to identify "near-optimal" hedging strategies. Sets of strategies that achieve near-optimal utility-a measure of utility in a neighborhood around the utility maximizing point-for a range of price scenarios are identified as robust marketing strategies. In addition, strategies that are robust to differences in producers' levels of risk aversion are identified. Robust strategies are compared to strategies commonly recommended by market advisors.