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Underwriting Assistance To The Australian Wheat Industry — An Application Of Option Pricing Theory

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  • Peter Bardsley
  • Paul Cashin

Abstract

For the ten crop seasons 1979-80 to 1988-89, returns to producers in the Australian wheat industry were underwritten by a government-guaranteed price floor. Similar schemes operate in other rural industries (dairy, apples and pears, dried fruits). Although the underwriting provisions have only been triggered once (in the 1986-87 season), the provision of this scheme has acted to reduce the risk normally associated with returns to producers of wheat in all years of its operation. This reduction in risk has been granted free-of-charge by the Commonwealth Government. The guaranteed price can be viewed as a put option taken out by the Government on behalf of growers - it gives growers the option to sell to the Australian Wheat Board at this floor price. The aim of this paper is to apply to this underwriting arrangement the Black-Scholes formula for valuing options, in order to estimate the cost that growers would otherwise have had to pay to obtain cover (through put options) equivalent to the guaranteed price. We also estimate the magnitude of this form of assistance to the industry, which (until now) has not been taken into account unless the returns to growers fell below the guaranteed price.

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File URL: http://hdl.handle.net/10.1111/j.1467-8489.1990.tb00496.x
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Bibliographic Info

Article provided by Australian Agricultural and Resource Economics Society in its journal Australian Journal of Agricultural and Resource Economics.

Volume (Year): 34 (1990)
Issue (Month): 3 (December)
Pages: 212-222

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Handle: RePEc:bla:ajarec:v:34:y:1990:i:3:p:212-222

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References

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  1. Butler, J. S. & Schachter, Barry, 1986. "Unbiased estimation of the Black/Scholes formula," Journal of Financial Economics, Elsevier, vol. 15(3), pages 341-357, March.
  2. Marcus, Alan J. & Modest, David M., 1986. "The Valuation of a Random Number of Put Options: An Application to Agricultural Price Supports," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(01), pages 73-86, March.
  3. Black, Fischer & Scholes, Myron S, 1972. "The Valuation of Option Contracts and a Test of Market Efficiency," Journal of Finance, American Finance Association, vol. 27(2), pages 399-417, May.
  4. Black, Fischer, 1976. "The pricing of commodity contracts," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 167-179.
  5. Dixit, A., 1988. "Entry And Exit Decisions Under Uncertainty," Papers 91, Princeton, Department of Economics - Financial Research Center.
  6. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June.
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Citations

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Cited by:
  1. Watson, Alistair S., 1996. "Principles of Grain Marketing: Some Lessons from Australian Experience," Technical Reports 113821, Australian Centre for International Agricultural Research.
  2. Johnson, R.W.M., 1992. "Risk and the Farm Firm: A Corporate Finance View," Review of Marketing and Agricultural Economics, Australian Agricultural and Resource Economics Society, vol. 60(01), April.
  3. Hertzler, Greg, 2000. "The Precautionary Principle in Practice: How to Write a Call Option on the Environment," 2000 Conference (44th), January 23-25, 2000, Sydney, Australia 123660, Australian Agricultural and Resource Economics Society.
  4. Richards, Timothy J. & Manfredo, Mark R., 2003. "Infrequent Shocks and Rating Revenue Insurance: A Contingent Claims Approach," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 28(02), August.
  5. Carter, Colin A. & Wilson, William W., 1997. "Emerging differences in state grain trading: Australia and Canada," Agricultural Economics, Blackwell, vol. 16(2), pages 87-98, May.
  6. Joseph F. Francois & Will Martin, 1998. "Commercial Policy Uncertainty, the Expected Cost of Protection, and Market Access," Tinbergen Institute Discussion Papers 98-059/2, Tinbergen Institute.

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