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Commodity procurement as contingent claims: Capturing risk and real options in flour milling

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  • William W. Wilson
  • Jesse Klebe

Abstract

Procurement, inventory, and stockholding strategies are important functions for agricultural commodity processing and trading. This paper's purpose is to develop an optimal inventory strategy for wheat in flour milling by considering the risks in margins and demand. We develop a model that views buffer stocks as real options for future sales. The model was applied to a representative wheat flour mill in the Upper Midwest and used prices for inputs, outputs, margins, and associated distributions and correlations. The base case results indicated that the optimal buffer stocks should be 20% more than expected demand in the base case, and vary in a logical way with changes in demand, market carry, and stockout penalties. Implications from these results illustrate that stockholding is an important element of agricultural processing. This approach indicates that managers should strategically manage inventory positions and purchases that result in buffer stocks. [EconLit citations: C6, L1, L7, L9, Q12, Q14]

Suggested Citation

  • William W. Wilson & Jesse Klebe, 2021. "Commodity procurement as contingent claims: Capturing risk and real options in flour milling," Agribusiness, John Wiley & Sons, Ltd., vol. 37(2), pages 348-370, April.
    • Handle: RePEc:wly:agribz:v:37:y:2021:i:2:p:348-370
    DOI: 10.1002/agr.21670
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    References listed on IDEAS

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