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More reasons why farmers have so little interest in futures markets

Listed author(s):
  • David J. Pannell
  • Getu Hailu
  • Alfons Weersink
  • Amanda Burt

The use by farmers of futures contracts and other hedging instruments has been observed to be low in many situations, and this has sometimes seemed to be considered surprising or even mysterious. We propose that it is, in fact, readily understandable and consistent with rational decision making. Standard models of the decision about optimal hedging show that it is negatively related to basis risk, to quantity risk, and to transaction costs. Farmers who have less uncertainty about prices and those with a diversified portfolio of investments have lower optimal levels of hedging. If a farmer has optimistic price expectations relative to the futures market, the incentive to hedge can be greatly reduced. And finally, farmers who have low levels of risk aversion have little to gain from hedging in terms of risk reduction, in that the certainty-equivalent payoff at their optimal hedge may be little different than the certainty equivalent under zero hedging. These reasons are additional to the argument of Simmons (2002) who showed that, if capital markets are efficient, farmers can manage their risk exposure through adjusting their leverage, obviating the need for hedging instruments. Copyright (c) 2008 International Association of Agricultural Economists.

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File URL: http://www.blackwell-synergy.com/doi/abs/10.1111/j.1574-0862.2008.00313.x
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Article provided by International Association of Agricultural Economists in its journal Agricultural Economics.

Volume (Year): 39 (2008)
Issue (Month): 1 (July)
Pages: 41-50

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Handle: RePEc:bla:agecon:v:39:y:2008:i:1:p:41-50
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  1. Bardsley, Peter & Harris, Michael, 1987. "An Approach To The Econometric Estimation Of Attitudes To Risk In Agriculture," Australian Journal of Agricultural Economics, Australian Agricultural and Resource Economics Society, vol. 31(02), August.
  2. Lence, Sergio H & Hayes, Dermot J, 1994. " Parameter-Based Decision Making under Estimation Risk: An Application to Futures Trading," Journal of Finance, American Finance Association, vol. 49(1), pages 345-357, March.
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  5. Sergio H. Lence & Dermot J. Hayes, 1993. "Empirical Minimum Variance Hedge, The," Center for Agricultural and Rural Development (CARD) Publications 93-wp109, Center for Agricultural and Rural Development (CARD) at Iowa State University.
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  7. B. Wade Brorsen, 1995. "Optimal Hedge Ratios with Risk-Neutral Producers and Nonlinear Borrowing Costs," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 77(1), pages 174-181.
  8. David J. Pannell, 2006. "Flat Earth Economics: The Far-reaching Consequences of Flat Payoff Functions in Economic Decision Making," Review of Agricultural Economics, Agricultural and Applied Economics Association, vol. 28(4), pages 553-566.
  9. Harvey Lapan & Giancarlo Moschini, 1994. "Futures Hedging Under Price, Basis, and Production Risk," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 76(3), pages 465-477.
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  16. Lubulwa, Milly & Beare, Stephen & Foster, Max & Bui-Lan, Anh, 1996. "Price Risk Reduction for Wool Growers Using the New Wool Futures Contract," 1996 Conference (40th), February 11-16, 1996, Melbourne, Australia 156428, Australian Agricultural and Resource Economics Society.
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  19. Ronald W. Anderson & Jean-Pierre Danthine, 1983. "The Time Pattern of Hedging and the Volatility of Futures Prices," Review of Economic Studies, Oxford University Press, vol. 50(2), pages 249-266.
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