A New and Dynamic Look at Forecasting MPP Margin Price

The recent Agricultural Act (Farm Bill) of 2014 considers a new insurance program for Dairy producers. The Margin Protection Program (MPP) accounts for the difference between the national average price of milk and feed, which includes corn, soybean meal and alfalfa. If this national dairy margin is below a threshold selected by the producer in their insurance contract, the producer receives an indemnity. A web-based tool available for access by dairy producers and/or dairy related stakeholders utilizes a method which forecasts this dairy margin, by making use of extensive futures and options market data. The method considers shocks to futures prices as the difference between a commodity’s expected price - given by its futures contract price at a certain date - and its eventual settled (terminal) price at expiration. These unexpected shocks are calculated monthly for each commodity according to their time-to-maturity, from one month ahead up to one year ahead (i.e. 12 different periods of price shocks). The inter-relationship (rank correlation) between the different ‘time-to-maturity’ shocks from these commodities is maintained when forecasting the futures (and subsequently cash) prices. However, these correlations are static - depending only on time-to-maturity of the different shocks - without incorporating additional information obtained from a growing crop season (e.g. method considers price deviates from March Corn futures expiring in September same as for September Corn futures expiring in March). Our method takes into account the arrival of new information during the farming season by incorporating time-varying (dynamic) correlations in the forecast method. In addition, we make use of dynamic copulas to model the joint time-varying interrelationship among these price shocks. Results obtained are of relative improvement in forecasting the actual margin, especially during the 1st three months. Discussion and remarks for future venues are provided