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An Insurance Approach to Risk Management in the Ethanol Industry

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

Abstract

The vast majority of crop and revenue insurance policies sold in the United States are single-crop policies that insure against low yields or revenues for each crop grown on the farm. But, increasingly, producer income is based more on the value of crops that have been converted into a value-added product such as ethanol. Moreover, the recent increases in energy and commodity price levels and volatilities emphasize the importance of risk management to ethanol investors. This paper uses an insurance approach to outline a risk management tool which mimics the gross margin level of a typical corn-based ethanol plant. The gross margin, premium, and indemnity levels are calculated on a per bushel basis to enable producers/investors to utilize the product based on their ownership share in the production facility. The fair premium rates are shown to be quite sensitive with respect to corn and energy price levels and volatilities.

Suggested Citation

  • Paulson, Nicholas D. & Babcock, Bruce & Hart, Chad E. & Hayes, Dermot J., 2008. "An Insurance Approach to Risk Management in the Ethanol Industry," ISU General Staff Papers 200804010700001514, Iowa State University, Department of Economics.
  • Handle: RePEc:isu:genstf:200804010700001514
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    File URL: http://lib.dr.iastate.edu/cgi/viewcontent.cgi?article=1514&context=econ_las_pubs
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    References listed on IDEAS

    as
    1. Amani Elobeid & Simla Tokgoz & Dermot J. Hayes & Bruce A. Babcock & Chad E. Hart, 2006. "Long-Run Impact of Corn-Based Ethanol on the Grain, Oilseed, and Livestock Sectors: A Preliminary Assessment, The," Center for Agricultural and Rural Development (CARD) Publications 06-bp49, Center for Agricultural and Rural Development (CARD) at Iowa State University.
    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. Levy, Edmond, 1992. "Pricing European average rate currency options," Journal of International Money and Finance, Elsevier, vol. 11(5), pages 474-491, October.
    6. 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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