Price Stabilization Policies and Futures Markets

Because of the short-term nature of existing futures contracts, farmers are subject to intertemporal income uncertainty, yet price stabilization may be detrimental because it negates the benefits of (intertemporal) production flexibility. Multiyear futures, if they existed, would be preferred to price stabilization, but they would not provide perfect hedging opportunities because the risk faced by farmers is nonlinear in price. This means that options may be useful hedging devices, and there may be scope for government intervention, even when long-term futures exist. The optimal price policy is not price stabilization, however, but it requires that support price to be positively correlated to the futures price that prevails when production decisions are made.