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Impacts of government risk management policies on hedging in futures and options:LPM2 hedge model vs. EU hedge model

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  • Zhang, Rui (Carolyn)
  • Houston, Jack E.
  • Vedenov, Dmitry V.
  • Barnett, Barry J.

Abstract

The main objective of this study is to compare the impacts of government payments and crop insurance policies on the use of futures and options measured from a downside risk hedge model with the impacts analyzed by the expected utility (EU) hedge model. Understanding the effects of government-provided risk management tools on the private market risk management tools, such as futures and options, provides value to both crop farmers and policy makers. Comparison of the impacts from the two hedge models shows that crop farmer will hedge less in futures under the LPM2 model than under the EU hedge model. This finding indicates that model misspecification is another reason for the phenomenon that farmers actually hedge less in futures than predicted by the EU model. From the perspective of exploring new research techniques, this study applied two relatively new simulation concepts, copula simulation and conditional kernel density approach, to make the simulation assumptions less restrictive and more consistent with observations. The copula simulation applied in this study allows yield and price to have more flexible joint distribution functions than multivariate normal; the conditional kernel density approach used in farm yield simulation enables the variance of farm yield varies with county yield rather than being constant.

Suggested Citation

  • Zhang, Rui (Carolyn) & Houston, Jack E. & Vedenov, Dmitry V. & Barnett, Barry J., 2008. "Impacts of government risk management policies on hedging in futures and options:LPM2 hedge model vs. EU hedge model," 2008 Conference, April 21-22, 2008, St. Louis, Missouri 37610, NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
  • Handle: RePEc:ags:nccest:37610
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    File URL: http://purl.umn.edu/37610
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    References listed on IDEAS

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    1. Coble, Keith H. & Heifner, Richard G. & Zuniga, Manuel, 2000. "Implications Of Crop Yield And Revenue Insurance For Producer Hedging," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 25(02), December.
    2. Barry J. Barnett & Dmitry V. Vedenov, 2007. "Is There a Viable Market for Area-Based Crop Insurance?," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 89(2), pages 508-519.
    3. Keith H. Coble, 2004. "The joint effect of government crop insurance and loan programmes on the demand for futures hedging," European Review of Agricultural Economics, Foundation for the European Review of Agricultural Economics, vol. 31(3), pages 309-330, September.
    4. Geoffrey Poitras, 1993. "Hedging and crop insurance," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 13(4), pages 373-388, June.
    5. Hanson, Steven D. & Myers, Robert J. & Hilker, James H., 1999. "Hedging With Futures And Options Under A Truncated Cash Price Distribution," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 31(03), December.
    6. Yong Sakong & Dermot J. Hayes & Arne Hallam, 1993. "Hedging Production Risk With Options," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 75(2), pages 408-415.
    7. Olivier Mahul, 2003. "Hedging price risk in the presence of crop yield and revenue insurance," European Review of Agricultural Economics, Foundation for the European Review of Agricultural Economics, vol. 30(2), pages 217-239, June.
    8. Hanson, Steven D. & Myers, Robert J. & Hilker, James H., 1999. "Hedging with Futures and Options under a Truncated Cash Price Distribution," Journal of Agricultural and Applied Economics, Cambridge University Press, vol. 31(03), pages 449-459, December.
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    More about this item

    Keywords

    Down-side Risk; LPM2 Hedge Model; Government Payments; Crop Insurance Policies; Copula Simulation; Conditional Kernel Density; Agricultural Finance;

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