IDEAS home Printed from https://ideas.repec.org/p/ags/umaesp/132379.html

Mean-reversion in Income over Feed Cost Margins:Evidence and Implications for Managing Margin Risk by U.S. Dairy Producers

Author

Listed:
  • Bozic, Marin
  • Newton, John
  • Thraen, Cameron S.
  • Gould, Brian W.

Abstract

With increased volatility of feed prices dairy farm managers are no longer concerned with managing just milk price volatility but are considering the adoption of risk management programs that address income over feed cost (IOFC) margin risk. Successful margin risk management should be founded on understanding of the behavior of IOFC margins. To that end, we construct forward IOFC margins using Class III milk, corn and soybean meal futures prices. We focus on the characteristics of the term structure of forward IOFC margins, i.e. the sequence of forward margins for consecutive calendar months, all observed on the same trading day. What is apparent from shapes of these term structures is that both in times when margins were exceptionally high and when they were disastrously low, market participants expected that a reversal back to average margin levels would not come quickly, but would rather take up to 9 months. Slopes of the forward margin term structure prior to and after most of the major swings in IOFC indicate these shocks were mostly unanticipated, while time needed for recovery to normal margin levels was successfully predicted. This suggests that IOFC margins may exhibit slow mean-reverting, rather than predictable cyclical behavior, as is often suggested in the popular press. This finding can be exploited to design a successful catastrophic risk management program by initiating protection at 9 to 12 months prior to futures contract maturity. As a case study, we analyze risk management strategies for managing IOFC margins that utilize Livestock Gross Margin for Dairy Cattle (LGM-Dairy) insurance contracts. We created two farm profiles where the first one represents dairy farms that grow most of their feed. The second profile is designed to capture the risk exposure of a dairy farm that purchases all their dairy herd, dry cow, and heifer feed. Our case study of this program encompasses the 2009 period which was characterized by exceptionally poor IOFC margin conditions. We analyzed the dynamics of realized IOFC margins in 2009 under four different risk management strategies, and found that optimal strategies that are founded on principles delineated above succeeded in reducing the decline IOFC margins in 2009 by 93% for home-feed and 47% for market-feed profile, and performed substantially better than alternative strategies suggested by earlier literature.

Suggested Citation

  • Bozic, Marin & Newton, John & Thraen, Cameron S. & Gould, Brian W., 2012. "Mean-reversion in Income over Feed Cost Margins:Evidence and Implications for Managing Margin Risk by U.S. Dairy Producers," Staff Papers 132379, University of Minnesota, Department of Applied Economics.
    • Handle: RePEc:ags:umaesp:132379
    DOI: 10.22004/ag.econ.132379
    as

    Download full text from publisher

    File URL: https://ageconsearch.umn.edu/record/132379/files/Bozic_APEC_SP12-6_final.pdf
    Download Restriction: no
    File URL: https://libkey.io/10.22004/ag.econ.132379?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Gould, Brian W. & Cabrera, Victor E., 2011. "USDA's Livestock Gross Margin Insurance for Dairy: What Is It and How Can It Be Used for Risk Management," Staff Paper Series 562, University of Wisconsin, Agricultural and Applied Economics.
    2. Fortenbery, T. Randall & Cropp, Robert A. & Zapata, Hector O., 1997. "Analysis of Expected Price Dynamics Between Fluid Milk Futures Contracts and Cash Prices for Fluid Milk," Journal of Agribusiness, Agricultural Economics Association of Georgia, vol. 15(2), pages 1-20.
    3. Bamba, Ibrahim & Maynard, Leigh J., 2004. "Hedging-Effectiveness of Milk Futures Using Value-At-Risk Procedures," 2004 Conference, April 19-20, 2004, St. Louis, Missouri 19028, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    4. Leigh J. Maynard & Christopher Wolf & Matthew Gearhardt, 2005. "Can Futures and Options Markets Hold the Milk Price Safety Net? Policy Conflicts and Market Failures in Dairy Hedging," Review of Agricultural Economics, Agricultural and Applied Economics Association, vol. 27(2), pages 273-286.
    5. Valvekar, Mayuri & Chavas, Jean P. & Gould, Brian W. & Cabrera, Victor E., 2011. "Revenue risk management, risk aversion and the use of Livestock Gross Margin for Dairy Cattle insurance," Agricultural Systems, Elsevier, vol. 104(9), pages 671-678.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Wolf, Christopher A. & Widmar, Nicole J. Olynk, 2014. "Adoption of Milk and Feed Forward Pricing Methods by Dairy Farmers," Journal of Agricultural and Applied Economics, Cambridge University Press, vol. 46(4), pages 527-541, November.
    2. Loughrey, J. & Thorne, F. & Kinsella, A. & Hennessy, T. & McDonnell, J. & O’Donoghue, C. & Vollenweider, X., 2014. "The Market Risk Perceptions And Management Of Irish Dairy Farmers," 88th Annual Conference, April 9-11, 2014, AgroParisTech, Paris, France 169760, Agricultural Economics Society.
    3. Loughrey, J. & Thorne, F. & Kinsella, A. & Hennessy, T. & O'Donoghue, C. & Vollenweider, X., . "Market risk management and the demand for forward contracts among Irish dairy farmers," International Journal of Agricultural Management, Institute of Agricultural Management, vol. 4(4).
    4. Hutchins, Jared & Hueth, Brent, 2021. "Supply Response in Dairy Farming: Evidence from Monthly, Animal-Level Data," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 47(01), January.
    5. Newton, John & Thraen, Cameron S. & Bozic, Marin, 2013. "Whither Dairy Policy? Evaluating Expected Government Outlays and Distributional Impacts of Alternative 2013 Farm Bill Dairy Title Proposals," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C. 153750, Agricultural and Applied Economics Association.
    6. MacDonald, James M. & Cessna, Jerry & Mosheim, Roberto, "undated". "Changing Structure, Financial Risks, and Government Policy for the U.S. Dairy Industry," Economic Research Report 262200, United States Department of Agriculture, Economic Research Service.
    7. Newton, John & Thraen, Cameron S., 2013. "Actuarially Fair or Foul? Asymmetric Information Problems in Dairy Margin Insurance," 2013 Conference, April 22-23, 2013, St. Louis, Missouri 285796, NCR-134/ NCCC-134 Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    8. Burdine, Kenneth H. & Kusunose, Yoko & Maynard, Leigh J. & Blayney, Don P. & Mosheim, Roberto, 2014. "Livestock Gross Margin–Dairy: An Assessment of Its Effectiveness as a Risk Management Tool and Its Potential to Induce Supply Expansion," Journal of Agricultural and Applied Economics, Cambridge University Press, vol. 46(2), pages 245-256, May.
    9. Wolf, Christopher & Bozic, Marin & Newton, John & Thraen, Cameron, 2013. "Moove Over: Will New Government-Sponsored Dairy Margin Insurance Crowd Out Private Market Risk Management Tools?," 2013 AAEA: Crop Insurance and the Farm Bill Symposium 156713, Agricultural and Applied Economics Association.
    10. Bozic, Marin & Fortenbery, T., 2015. "Price Discovery, Volatility Spillovers and Adequacy of Speculation when Spot Prices are Stationary: The Case of U.S. Dairy Markets," 2015 Conference, August 9-14, 2015, Milan, Italy 211369, International Association of Agricultural Economists.
    11. Mosheim, Roberto & Blaney, Don & Burdine, Kenneth H. & Maynard, Leigh J., 2014. "Livestock Gross Margin-Dairy Insurance: An Assessment of Risk Management and Potential Supply Impacts," Economic Research Report 164606, United States Department of Agriculture, Economic Research Service.
    12. Bozic, Marin & Newton, John & Thraen, Cameron S. & Gould, Brian W., 2012. "Parametric Bootstrap Tests for Futures Price and Implied Volatility Biases with Application to Rating Livestock Margin Insurance for Dairy Cattle," Staff Papers 135077, University of Minnesota, Department of Applied Economics.
    13. Newton, John & Thraen, Cameron S., 2014. "Chewing the Cud on Using Multi-Commodity Hedge Ratios To Manage Dairy Farm Risk," 2014 Conference, April 21-22, 2014, St. Louis, Missouri 285819, NCR-134/ NCCC-134 Applied Commodity Price Analysis, Forecasting, and Market Risk Management.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Newton, John & Thraen, Cameron S., 2014. "Chewing the Cud on Using Multi-Commodity Hedge Ratios To Manage Dairy Farm Risk," 2014 Conference, April 21-22, 2014, St. Louis, Missouri 285819, NCR-134/ NCCC-134 Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    2. Altman, Ira J. & Sanders, Dwight & Schneider, Jonathan, 2008. "Producer-Level Hedging Effectiveness of Class III Milk Futures," Journal of the ASFMRA, American Society of Farm Managers and Rural Appraisers, vol. 2008, pages 1-8.
    3. Burdine, Kenneth H. & Kusunose, Yoko & Maynard, Leigh J. & Blayney, Don P. & Mosheim, Roberto, 2014. "Livestock Gross Margin–Dairy: An Assessment of Its Effectiveness as a Risk Management Tool and Its Potential to Induce Supply Expansion," Journal of Agricultural and Applied Economics, Cambridge University Press, vol. 46(2), pages 245-256, May.
    4. Burdine, Kenneth H. & Maynard, Leigh J., 2012. "Risk Reduction of LGM-Dairy and its Potential Impact on Production," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington 124180, Agricultural and Applied Economics Association.
    5. Newton, John & Thraen, Dr. Cameron, 2012. "Road Block to Risk Management - How Federal Milk Pricing Provisions Complicate Class 1 Cross-Hedging Incentives," 2012 Conference, April 16-17, 2012, St. Louis, Missouri 285768, NCR-134/ NCCC-134 Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    6. Sanders, Dwight R. & Schneider, Jonathan & Altman, Ira J., 2007. "Producer-Level Hedging Effectiveness of Class III Milk Futures," 2007 Annual Meeting, February 4-7, 2007, Mobile, Alabama 34983, Southern Agricultural Economics Association.
    7. Neyhard, James & Tauer, Loren & Gloy, Brent, 2013. "Analysis of Price Risk Management Strategies in Dairy Farming Using Whole-Farm Simulations," Journal of Agricultural and Applied Economics, Cambridge University Press, vol. 45(2), pages 313-327, May.
    8. Mosheim, Roberto & Blaney, Don & Burdine, Kenneth H. & Maynard, Leigh J., 2014. "Livestock Gross Margin-Dairy Insurance: An Assessment of Risk Management and Potential Supply Impacts," Economic Research Report 164606, United States Department of Agriculture, Economic Research Service.
    9. Bozic, Marin & Newton, John & Thraen, Cameron S. & Gould, Brian W., 2012. "Livestock Gross Margin Insurance for Dairy: Designing Margin Insurance Contracts to Account for Tail Dependence Risk," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington 124718, Agricultural and Applied Economics Association.
    10. Newton, John, . "Price Transmission in Global Dairy Markets," International Food and Agribusiness Management Review, International Food and Agribusiness Management Association, vol. 19(B), pages 1-15.
    11. Bozic, Marin & Newton, John & Thraen, Cameron S. & Gould, Brian W., 2014. "Parametric Bootstrap Tests for Futures Price and Implied Volatility Biases With Application to Rating Dairy Margin Insurance," 2014 Annual Meeting, July 27-29, 2014, Minneapolis, Minnesota 170416, Agricultural and Applied Economics Association.
    12. Jeffrey A Frankel & Andrew K Rose, 2010. "Determinants of Agricultural and Mineral Commodity Prices," RBA Annual Conference Volume (Discontinued), in: Renée Fry & Callum Jones & Christopher Kent (ed.),Inflation in an Era of Relative Price Shocks, Reserve Bank of Australia.
    13. Fernandez-Perez, Adrian & Frijns, Bart & Gafiatullina, Ilnara & Tourani-Rad, Alireza, 2022. "Profit margin hedging in the New Zealand dairy farming industry," Journal of Commodity Markets, Elsevier, vol. 26(C).
    14. Bozic, Marin & Fortenbery, T., 2015. "Price Discovery, Volatility Spillovers and Adequacy of Speculation when Spot Prices are Stationary: The Case of U.S. Dairy Markets," 2015 Conference, August 9-14, 2015, Milan, Italy 211369, International Association of Agricultural Economists.
    15. O'Connor, Declan & Keane, Michael & Barnes, Edel, 2008. "Managing Price Risk in a Changing Policy Environment: The Case of the EU Dairy Industry," 108th Seminar, February 8-9, 2008, Warsaw, Poland 48112, European Association of Agricultural Economists.
    16. Bozic, Marin & Newton, John & Thraen, Cameron S. & Gould, Brian W., 2012. "Parametric Bootstrap Tests for Futures Price and Implied Volatility Biases with Application to Rating Livestock Margin Insurance for Dairy Cattle," Staff Papers 135077, University of Minnesota, Department of Applied Economics.
    17. Nawazish Mirza & Krishna Reddy & Amir Hasnaoui & Peter Yates, 2020. "A Comparative Analysis of the Hedging Effectiveness of Farmgate Milk Prices for New Zealand and United States Dairy Farmers," Journal of Quantitative Economics, Springer;The Indian Econometric Society (TIES), vol. 18(1), pages 129-142, March.
    18. Newton, John & Thraen, Cameron S., 2013. "Actuarially Fair or Foul? Asymmetric Information Problems in Dairy Margin Insurance," 2013 Conference, April 22-23, 2013, St. Louis, Missouri 285796, NCR-134/ NCCC-134 Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    19. Newton, John & Thraen, Cameron S. & Bozic, Marin, 2013. "Whither Dairy Policy? Evaluating Expected Government Outlays and Distributional Impacts of Alternative 2013 Farm Bill Dairy Title Proposals," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C. 153750, Agricultural and Applied Economics Association.
    20. Aleksandra Figurek & Ernst Stadlober & Vojo Radić, 2017. "Evaluating the Business Results of Dairy Farms in Bosnia and Herzegovina," Journal of Applied Management and Investments, Department of Business Administration and Corporate Security, International Humanitarian University, vol. 6(4), pages 244-252, November.

    More about this item

    Keywords

    ;
    ;

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ags:umaesp:132379. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: AgEcon Search (email available below). General contact details of provider: https://edirc.repec.org/data/daumnus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.