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Insuring uncertainty in value-added agriculture: ethanol

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  • Paulson, Nicholas David

Abstract

A wide variety of insurance products are currently available for 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 become increasingly popular among farmers over the last decade; however, insurance against declines in the value-added portion of their crops is not yet available. This paper outlines the development of an insurance product aimed at corn producers who are members of an ethanol production cooperative. The product mimics the gross margin level of a typical ethanol production facility, and has the potential to provide 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 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 David, 2004. "Insuring uncertainty in value-added agriculture: ethanol," ISU General Staff Papers 2004010108000018198, Iowa State University, Department of Economics.
  • Handle: RePEc:isu:genstf:2004010108000018198
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    File URL: http://lib.dr.iastate.edu/cgi/viewcontent.cgi?article=18198&context=rtd
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    References listed on IDEAS

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    1. Buschena, David E. & Ziegler, Lee, 1999. "Reliability Of Options Markets For Crop Revenue Insurance Rating," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 24(02), December.
    2. 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.
    3. 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(03), pages 377-389, September.
    4. Chad E. Hart & Dermot J. Hayes & Bruce A. Babcock, 2006. "Insuring Eggs in Baskets: Should the Government Insure Individual Risks?," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 54(1), pages 121-137, March.
    5. Melick, William R. & Thomas, Charles P., 1997. "Recovering an Asset's Implied PDF from Option Prices: An Application to Crude Oil during the Gulf Crisis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 32(01), pages 91-115, March.
    6. Levy, Edmond, 1992. "Pricing European average rate currency options," Journal of International Money and Finance, Elsevier, vol. 11(5), pages 474-491, October.
    7. Chad E. Hart & Dermot J. Hayes & Bruce A. Babcock, 2006. "Insuring Eggs in Baskets: Should the Government Insure Individual Risks?," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 54(1), pages 121-137, March.
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    Cited by:

    1. Zhu, Jianhua & Jolly, Robert W., 2005. "Dynamic Dividend and Investment Decisions in Value Added Firms: An Application to Farmer Owned Ethanol Plants," Proceedings: 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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