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Net income risk, crop insurance and hedging

Author

Listed:
  • Cory Walters
  • Richard Preston

Abstract

Purpose - At the beginning of the production year producers face a complex risk management decision environment given by risks specific to their operation, multiple crop insurance contracts and hedging opportunities. The purpose of this paper is to provide a producer-level framework for risk management decision making, focusing on the interaction between crop insurance and hedging. Design/methodology/approach - The authors develop a Monte Carlo simulation model that generates a producer’s net income (NI) distribution that incorporates historical producer risk, price-yield correlation via a copula, price risk, and production costs. The authors evaluate the NI distribution through a modified Modern Portfolio Theory (MPT) decision framework. The authors use the modified MPT decision framework to explore tradeoffs between expected NI and farm ruin (defined as 1 or 5 percent expected shortfall) from different crop insurance contracts and pre-harvest hedging options. Findings - Only revenue protection and the highest two levels of coverage level exist on the efficient frontier. The level of hedging on the efficient frontier ranges from 0 to 55 percent of Actual Production History. The authors find that increasing coverage level 5 percent (from 80 to 85 percent) negatively impacts the optimal hedging amount by 26 percentage points (from 35 to 9 percent). Originality/value - The model provides the precise identification of financial benefits from different risk management strategies by incorporating producer-level historical yield data, using a copula to capture yield-price dependency structure and producer production cost in generating the NI distribution. This model can be applied to any producer’s characteristics and data.

Suggested Citation

  • Cory Walters & Richard Preston, 2017. "Net income risk, crop insurance and hedging," Agricultural Finance Review, Emerald Group Publishing Limited, vol. 78(1), pages 135-151, December.
  • Handle: RePEc:eme:afrpps:afr-05-2017-0036
    DOI: 10.1108/AFR-05-2017-0036
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    Citations

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    Cited by:

    1. Sharma, S. & Walters, C., 2018. "Influence of Farm and Lease Type on Crop Insurance Returns," 2018 Conference, July 28-August 2, 2018, Vancouver, British Columbia 277399, International Association of Agricultural Economists.
    2. Xi Zhang & Xu Wu & Linlin Zhang & Zhonglu Chen, 2022. "The Evaluation of Mean-Detrended Cross-Correlation Analysis Portfolio Strategy for Multiple risk Assets," Evaluation Review, , vol. 46(2), pages 138-164, April.
    3. Kulawik, Jacek & Płonka, Renata & Wieliczko, Barbara, 2020. "Changes in The Income Situation of Agricultural Holdings in The Light of The Polish FADN Observations from 2004-2018," Problems of Agricultural Economics / Zagadnienia Ekonomiki Rolnej 311271, Institute of Agricultural and Food Economics - National Research Institute (IAFE-NRI).

    More about this item

    Keywords

    Hedging; Copula; Crop insurance; Net income risk; Q13;
    All these keywords.

    JEL classification:

    • Q13 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Agricultural Markets and Marketing; Cooperatives; Agribusiness

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