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The Paradox of Risk Balancing: Do Risk-reducing Policies Lead to More Risk for Farmers?

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  • Cheng, Mei-luan
  • Gloy, Brent A.
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    Abstract

    The study presents stochastic optimal control/dynamic programming (SOC/DP) to derive the optimal debt level and consumption in farm models concerning two sources of uncertainty: the return on assets and interest rate. The SOC/DP analytic framework is used to analyze the impacts of risk-reducing farm policies on farm’s financial and risk adjustments. The results show the violations of the risk-balancing concept, which theorizes that risk-reducing farm policies may lead to increases in financial leverage, total risk, and the expected returns. Also, this study examines the extent to which the estimates of the optimal debt level are biased when interest rate risk is ignored.

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    File URL: http://purl.umn.edu/6546
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    Bibliographic Info

    Paper provided by American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association) in its series 2008 Annual Meeting, July 27-29, 2008, Orlando, Florida with number 6546.

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    Date of creation: 2008
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    Handle: RePEc:ags:aaea08:6546

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    Related research

    Keywords: Stochastic Optimal Control/Dynamic Programming; Financial Leverage; Uncertainty; Risk Balancing; Agricultural and Food Policy; Risk and Uncertainty;

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    1. Stein, Jerome L., 2006. "Stochastic Optimal Control, International Finance, and Debt Crises," OUP Catalogue, Oxford University Press, number 9780199280575, October.
    2. Stein, J.L. & Zheng, Ziyu, 2007. "Inter-temporal optimization in a stochastic environment: Introduction," Journal of Banking & Finance, Elsevier, vol. 31(5), pages 1287-1293, May.
    3. Harwood, Joy L. & Heifner, Richard G. & Coble, Keith H. & Perry, Janet E. & Somwaru, Agapi, 1999. "Managing Risk in Farming: Concepts, Research, and Analysis," Agricultural Economics Reports 34081, United States Department of Agriculture, Economic Research Service.
    4. Goldstein, Robert & Ju, Nengjiu & Leland, Hayne, 2001. "An EBIT-Based Model of Dynamic Capital Structure," The Journal of Business, University of Chicago Press, vol. 74(4), pages 483-512, October.
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    Cited by:
    1. Uzeaa, Florentina Nicoleta & Poon, Kenneth & Sparling, David & Weersink, Alfons, 2013. "Farm Support Payments and Risk Balancing: Implications for Financial Riskiness of Canadian Farms," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C. 150708, Agricultural and Applied Economics Association.

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