Intertemporal Risk Management in Agriculture

Agricultural production is subject to supply risk. Expected and realized farm outputs and output prices are unknown and unobservable when inputs are chosen. Crop and livestock production decisions are linked over time. Producers’ expectations are particularly difficult to model. This paper presents the necessary and sufficient condition to allow input demands to be specified as functions of input prices, technology, quasi-fixed inputs, and cost in place of planned/expected outputs. These are all observable when inputs are committed to production. Next we derive a flexible, exactly aggregable, economically regular econometric model of input demands. This model is consistent with any dynamic von Newman – Morgenstern expected utility function. We combine this framework with a model of the life-cycle production, investment and savings, and consumption decisions of owner/operators who face output and output price risk, and who have opportunities to invest in a conditionally risk free asset, other risky financial assets, and farm assets. The econometric framework allows for location specific technological change and production processes, cross-equation, interspatial, and intertemporal correlation among the error terms, and structural simultaneity between inputs and outputs, input and output prices, investment in durable goods used in agriculture, consumption, savings, and wealth. The result is a consistent dynamic structural model of inputs, outputs, savings, investment, and consumption under risk. We apply this model at the national-level to crop and livestock production for the years 1960-1999.