The impact of US commodity programmes on hedging in the presence of crop insurance

Wang, H. Holly; Makus, Larry D.; Chen, Xiaomei

doi:10.1093/erae/31.3.331

Cited by 17 publications

(10 citation statements)

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“…The expected income result supports the finding that it is important to consider hedging costs by Lence (1996). For the risk reduction result our results supports the finding that hedging with insurance plays a limited role in risk management (especially when compared to the risk reduction offered Wang et al (2004). Increasing hedging past 55 to 70 percent with 85 percent coverage level resulted in a slightly higher risk and lower expected NI.…”

Section: Ni Risk Crop Insurance and Hedgingsupporting

confidence: 81%

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Net income risk, crop insurance and hedging

Walters

Preston²

2017

AFR

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Purpose At the beginning of the production year producers face a complex risk management decision environment given by risks specific to their operation, multiple crop insurance contracts and hedging opportunities. The purpose of this paper is to provide a producer-level framework for risk management decision making, focusing on the interaction between crop insurance and hedging. Design/methodology/approach The authors develop a Monte Carlo simulation model that generates a producer’s net income (NI) distribution that incorporates historical producer risk, price-yield correlation via a copula, price risk, and production costs. The authors evaluate the NI distribution through a modified Modern Portfolio Theory (MPT) decision framework. The authors use the modified MPT decision framework to explore tradeoffs between expected NI and farm ruin (defined as 1 or 5 percent expected shortfall) from different crop insurance contracts and pre-harvest hedging options. Findings Only revenue protection and the highest two levels of coverage level exist on the efficient frontier. The level of hedging on the efficient frontier ranges from 0 to 55 percent of Actual Production History. The authors find that increasing coverage level 5 percent (from 80 to 85 percent) negatively impacts the optimal hedging amount by 26 percentage points (from 35 to 9 percent). Originality/value The model provides the precise identification of financial benefits from different risk management strategies by incorporating producer-level historical yield data, using a copula to capture yield-price dependency structure and producer production cost in generating the NI distribution. This model can be applied to any producer’s characteristics and data.

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Section: Ni Risk Crop Insurance and Hedgingsupporting

confidence: 81%

“…Mahul (2003) found that revenue insurance tends to result in lower demand for futures contracts. Wang et al (2004) found RP negatively affects the level of futures hedging and hedging or combining hedging with crop insurance plays a limited role in risk management.…”

Section: Literature Reviewmentioning

confidence: 99%

Net income risk, crop insurance and hedging

Walters

Preston²

2017

AFR

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“…We tested a range of values for the relative risk aversion parameter from .5 to 4. This range encompasses the values usually used in the literature in econometric studies (Cardenas and Carpenter, 2008) as well as in theoretical or ex ante frameworks in developing countries (Coble et al, 2004;Wang et al, 2004;Carter et al, 2007 andFafchamps, 2003). A relative risk aversion of 4 may seem high but empirical estimates of relative risk aversion indicate a wide variation across individuals; therefore, if insurance is not compulsory, only the most risk adverse farmers are likely to be insured, so such a high value is not unrealistic.…”

Section: Parameter Optimizationmentioning

confidence: 99%

Weather Index Drought Insurance: An Ex Ante Evaluation for Millet Growers in Niger

Leblois

Quirion

Alhassane

et al. 2013

Environ Resource Econ

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In the Sudano-Sahelian region, which includes South Niger, the inter-annual variability of the rainy season is high and irrigation is scarce. As a consequence, bad rainy seasons have a massive impact on crop yield and regularly entail food crises. Traditional insurances based on crop damage assessment are not available because of asymmetric information and high transaction costs compared to the value of production. We assess the risk mitigation capacity of an alternative form of insurance which has been implemented in India since 2003: insurance based on a weather index. We compare the capacity of various weather indices to increase utility of a representative risk-averse farmer. We show the importance of using plot-level yield data rather than village averages, which bias results upward. We also illustrate the need for out-ofsample estimations in order to avoid overfitting. Even with the appropriate index and assuming a substantial risk aversion, we find a limited gain of implementing insurance, roughly corresponding to the cost of implementing such insurances observed in India. However, when we treat separately the plots with and without fertilizers, we show that the benefit of insurance is higher in the former case. This suggests that insurances may increase the use of risk-increasing inputs like fertilizers and improved cultivars, hence average yields, which are very low in the region.

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“…In the context of the crop insurance industry, numerous studies had analyzed the issue of farmers hedging the uninsured price risk associated with revenue or yield insurance (Coble et al 2000;Coble et al 2004;Jacobs et al 2018;Mahul, 2003;Mahul & Vermersch, 2000;Walters & Preston 2018;Wang et al, 2004,). Most of these studies had examined the relationship between risk management tools (such as futures and options) and crop insurance and discovered that revenue insurance availability lowers the demand for hedging (Coble et al 2000;Coble et al 2004;Walters & Preston 2018).…”

Section: Literature Reviewmentioning

confidence: 99%

Hedging the Price Risk Inherent in Revenue Protection Insurance

Tiwari

Coble

Barnett

et al. 2021

J. Agric. Appl. Econ.

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Crop revenue insurance is unique, because it involves a guarantee subsuming yield risk and highly systematic price risk. This study examines whether crop insurers could use options instead of, or in addition to, assigning policies to the Commercial Funds of the USDA Federal Crop Insurance Corporation (FCIC) as per the Standard Reinsurance Agreement (SRA) to hedge the price risk of revenue insurance policies. The behavioral model examines the optimal hedge ratio for a crop insurer with a book of business consisting of corn Revenue Protection (RP) policies. Results show that a mix of put and call options can hedge the price risk of the RP policies. The higher optimal hedge ratios of call options as compared to put options imply that the risk of increased liability due to upside price risk can be hedged using options better than downside price risk. This study also analyzed the combination of options with the SRA at 35, 50, and 75% retention levels. The zero optimal hedge ratios at each retention level and the negative correlation between RP indemnities and the option returns when the crop insurer mixed options and SRA suggest that the purchasing of options provides no additional risk protection to crop insurers beyond what is provided by the SRA despite retention limits.

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The impact of US commodity programmes on hedging in the presence of crop insurance

Cited by 17 publications

References 0 publications

Net income risk, crop insurance and hedging

Net income risk, crop insurance and hedging

Weather Index Drought Insurance: An Ex Ante Evaluation for Millet Growers in Niger

Hedging the Price Risk Inherent in Revenue Protection Insurance

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