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Insuring Uncertainty In Value-Added Agriculture: Ethanol Production

Author

Listed:
  • Paulson, Nicholas D.
  • Babcock, Bruce A.
  • Hart, Chad E.
  • Hayes, Dermot J.

Abstract

A wide variety of insurance products is available to agricultural producers to insure against yield or price risks in the markets for the raw commodities they produce. Value-added enterprises, such as ethanol production, have been expanding over the last decade. This paper outlines the development of an insurance product aimed at corn producers who are members of an ethanol production cooperative. The product has the potential to provide these producers with a new and useful risk management tool to insure against price risks in the markets for corn, distillers dried grains with solubles (DDGS), ethanol, and natural gas. Monte Carlo analysis is used to develop fair premiums at various coverage levels. A historical correlation structure is imposed on the simulated price data using a method proposed by Iman and Conover (1982), which maintains the marginal distributions of the variables. Historical analysis is carried out to examine how the product would have performed had it been offered over the last decade. The product is shown to perform as intended, paying indemnities in years of extreme price volatility.

Suggested Citation

  • Paulson, Nicholas D. & Babcock, Bruce A. & Hart, Chad E. & Hayes, Dermot J., 2004. "Insuring Uncertainty In Value-Added Agriculture: Ethanol Production," Hebrew University of Jerusalem Archive 18375, Hebrew University of Jerusalem.
    • Handle: RePEc:ags:hebarc:18375
    DOI: 10.22004/ag.econ.18375
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    References listed on IDEAS

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    1. Chad E. Hart & Bruce A. Babcock & Dermot J. Hayes, 2001. "Livestock Revenue Insurance," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 21(6), pages 553-580, June.
    2. Turnbull, Stuart M. & Wakeman, Lee Macdonald, 1991. "A Quick Algorithm for Pricing European Average Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(3), pages 377-389, September.
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    2. Doering, Otto C., III, . "U.S. Ethanol Policy: Is It the Best Energy Alternative?," CAFRI: Current Agriculture, Food and Resource Issues, Canadian Agricultural Economics Society, issue 5, pages 1-8.
    3. Kebede, Ellene & Duffy, Patricia A. & Zabawa, Robert, 2006. "The Effect of Ethanol Production on Agricultural Production in the State of Alabama," 2006 Annual Meeting, February 5-8, 2006, Orlando, Florida 35415, Southern Agricultural Economics Association.
    4. Zhu, Jianhua & Jolly, Robert W., 2005. "Dynamic Dividend and Investment Decisions in Value Added Firms: An Application to Farmer Owned Ethanol Plants," 2005 Agricultural and Rural Finance Markets in Transition, October 3-4, 2005, Minneapolis, Minnesota 132765, Regional Research Committee NC-1014: Agricultural and Rural Finance Markets in Transition.

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