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Can rent adjustment clauses reduce the income risk of farms?

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  • Hotopp, Henning
  • Mußhoff, Oliver
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    Abstract

    Risk management is gaining importance in agriculture. In addition to traditional instruments, new risk management instruments are increasingly being proposed. These proposals include the rent adjustment clauses (RACs), which seem to be an unusual instrument at first sight. In contrast with conventional instruments, RACs intentionally allow fixed-cost ‘rent payments’ to fluctuate. We investigate the whole-farm risk reduction potential of different types of RACs via a historical simulation. The change in standard deviation and the value at risk (VaR) of the total gross margin (TGM) measure risk reduction potential. Our results revealed that RACs contribute to farm risk management. However, the trade-off between moral hazard and basis risk must be considered. Our proposal of weather index-based RAC seems to be a ‘good compromise’: the problem of moral hazard is completely eliminated by objectively measuring weather data. At the same time, the risk reduction potential of precipitation-based clauses, for example, is comparatively high.

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    File URL: http://purl.umn.edu/159237
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    Bibliographic Info

    Article provided by Institute of Agricultural Management & International Farm Management Association in its journal International Journal of Agricultural Management.

    Volume (Year): 01 (2012)
    Issue (Month): 4 (July)
    Pages:

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    Handle: RePEc:ags:ijameu:159237

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    Web page: http://www.ijagman.org

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    Web page: http://www.ifmaonline.org/
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    Related research

    Keywords: Risk management; rent adjustment clause; moral hazard; basis risk; weather index; value at risk; Farm Management; Financial Economics; Land Economics/Use; Risk and Uncertainty;

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    1. Allen, Douglas W. & Lueck, Dean, 1999. "Searching For Ratchet Effects In Agricultural Contracts," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 24(02), December.
    2. Vedenov, Dmitry V. & Barnett, Barry J., 2004. "Efficiency of Weather Derivatives as Primary Crop Insurance Instruments," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 29(03), December.
    3. Menale Kassie & Stein Holden, 2007. "Sharecropping efficiency in Ethiopia: threats of eviction and kinship," Agricultural Economics, International Association of Agricultural Economists, vol. 37(2-3), pages 179-188, 09.
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    6. Keita Fukunaga & Wallace E. Huffman, 2009. "The Role of Risk and Transaction Costs in Contract Design: Evidence from Farmland Lease Contracts in U.S. Agriculture," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 91(1), pages 237-249.
    7. Ghatak, Maitreesh & Pandey, Priyanka, 2000. "Contract choice in agriculture with joint moral hazard in effort and risk," Journal of Development Economics, Elsevier, vol. 63(2), pages 303-326, December.
    8. Calum G. Turvey, 2005. "The pricing of degree-day weather options," Agricultural Finance Review, Emerald Group Publishing, vol. 65(1), pages 59-85, May.
    9. Marc F. Bellemare, 2009. "Sharecropping, Insecure Land Rights and Land Titling Policies: A Case Study of Lac Alaotra, Madagascar," Development Policy Review, Overseas Development Institute, vol. 27(1), pages 87-106, 01.
    10. Barry K. Goodwin & Alan P. Ker, 1998. "Nonparametric Estimation of Crop Yield Distributions: Implications for Rating Group-Risk Crop Insurance Contracts," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 80(1), pages 139-153.
    11. Ernst Berg & Bernhard Schmitz, 2008. "Weather-based instruments in the context of whole-farm risk management," Agricultural Finance Review, Emerald Group Publishing, vol. 68(1), pages 119-133, September.
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