Risk Management
Alternative techniques for representing dependencies among variables in multivariate simulation are discussed and compared in the context of rating a whole-farm insurance product. A procedure by Iman and Conover (IC) that is common in actuarial applications is compared to a new technique detailed by Phoon, Quek, and Huang (PQH). Results suggest that rates derived from the IC procedure may be inaccurate because the procedure produces biased estimates of correlation between simulated variables. This situation is improved with the PQH procedure.
- Harri, A., J. D. Anderson, J. M. Riley, and K. H. Coble. "Optimal Hedging Strategies for Fed Cattle Priced in Value-Based Marketing Systems." Agricultural Economics, 40,3(2009):295-306.
This research investigates optimal price risk management strategies for fed cattle producers engaged in grid pricing. Stochastic simulation is used to determine optimal hedge ratios for fed cattle priced on a liveweight basis or on a series of grids that vary in terms of premium/discount structure as well as base price. Results indicate that the optimal hedging strategy is greatly affected by the base price used in a particular grid. This has significant implications for pricing efficiency in the cattle market. Base prices that are linked more closely with downstream markets offer the potential to improve pricing efficiency; however, the risk associated with these prices is difficult to manage effectively with existing futures instruments.
- Harri, A., C. Erdem, K. H. Coble, and T. O. Knight. "Crop Yield Normality: A Reconciliation of Previous Research." Review of Agricultural Economics, 31,1(2009):163-182.
This study revisits the large but inconclusive body of research on crop yield distributions. Using competing techniques across 3852 crop/county combinations we can reconcile some inconsistencies in previous studies. We examine linear, polynomial, and ARIMA trend models. Normality tests are undertaken, with an implementable R-test and multivariate testing to account for spatial correlation. Empirical results show limited support for stochastic trends in yields. Results also show that normality rejection rates depend on the trend specification. Corn Belt corn and soybeans yields are negatively skewed while they tend to become more normal as one moves away from the Corn Belt.
In an invited presentation at the 2010 Cotton Beltwide conference Keith Coble describes the major issues in managing cotton risk today. An assessment of the interactions between government programs to management price, yield and revenue risk are discussed as well as the interaction between forward pricing and government programs.
Climate change adaptation investments must be carefully allocated across interventions that improve risk mitigation and/or risk transfer. Weather index insurance is one mechanism for transferring the risk of extreme weather events. However, adaptation involves much more than just insurance! Weather index insurance will not insure against the longer run secular trend in weather variables caused by climate change. Insurance premium subsidies can actually create disincentives for adaptation.
The primary advantages of index insurance are that there is no need to estimate actual losses experienced by the policyholder, there is no need to classify policyholders' risk exposure, there is little potential for adverse selection and moral hazard, and operating costs are low. The primary disadvantages are basis risk and high start-up costs.
- Collier, B., J.R. Skees, and Barry J. Barnett. July 2009. "Weather Index Insurance and Climate Change: Opportunities and Challenges in Lower Income Countries." Geneva Papers on Risk and Insurance - Issues and Practice 34:401-424.
Multilateral institutions have suggested that weather index insurance could enhance the ability of stakeholders in lower income countries to adapt to climate change. While weather index insurance could have several benefits in this context (e.g. providing a safety net to vulnerable households and price signals regarding the weather risk), climate change impacts increase the price of insurance due to increasing weather risk. Uncertainty about the extent of regional impacts compounds pricing difficulties. Policy recommendations for insurance market development include funding risk assessments, start-up costs and the extreme layer of risk. General premium subsidies are cautioned against as they may actually slow household adaptation.
This Choices theme is premised on an assumption that agriculture has entered a new era of increased instability. Among the causes posited for this increased instability are the recent integration of the agriculture and energy sectors through bioenergy markets and the macroeconomic consequences of the current recession and credit crisis. While increased volatility in some agricultural commodity prices has been observed recently, whether agriculture has actually entered a new era of long-run increased instability is, we believe, open to some question. History is replete with "new eras" in American agriculture-most of which were amazingly short-lived.
- Barnett, B.J., C.B. Barrett, and J.R. Skees. October 2008. "Poverty Traps and Index-based Risk Transfer Products." World Development 36:1766-1785.
A growing literature suggests that in low-income countries, households with few assets can be trapped in chronic poverty. This article reviews relevant threads of the poverty traps literature to motivate a description of the opportunities presented by innovative index-based risk transfer products. These products can be used to address some insurance and credit market failures that contribute to the persistence of poverty among households in low-income countries. Applications are considered at the micro, meso, and macro levels.
This document reviews the English-language economic literature on agricultural risk in developed countries.
Moving from price-triggered to area revenue-triggered programs was perhaps the most common theme among 2007 farm bill proposals. Area revenue-triggered commodity programs may make farm-level revenue insurance products seem redundant, raising questions about why the federal government should continue both programs. Area revenue-triggered programs would remove much of the systemic risk faced by producers. As a result, private sector insurers may be able to insure the residual risk without federal involvement. This paper examines the effects of moving to area revenue-triggered commodity programs with a focus on public policy issues that would likely arise.
Three index-based crop insurance contracts are evaluated for representative south Georgia corn farms. The insurance contracts considered are based on indexes of historical county yields, yields predicted from a cooling degree-day production model, and yields predicted from a crop-simulation model. For some of the representative farms, the predicted yield index contracts provide yield risk protection comparable to the contract based on historical county yields, especially at lower levels of risk aversion. The impact of constraints on index insurance choice variables is considered and important interactions among constrained, conditionally optimized, choice variables are analyzed.
- Skees, J.R., B.J. Barnett, and B. Collier. April 2008. "Agricultural Insurance: Background and Context for Climate Adaptation Discussions." Paper presented at Organization for Economic Cooperation and Development (OECD) Expert Workshop on Economic Aspects of Adaptation, Paris, France.
This paper addresses the important question of whether agricultural insurance can facilitate farm household adaptation to climate change. The focus is on lower income countries and the emergence of index insurance as a new tool for delivering more cost-effective insurance to countries dominated by small farms. While agricultural insurance can provide needed funds when extreme weather events impact the livelihood of farmers, these funds will not necessarily be used for adaptation to climate change. Subsidizing agricultural insurance premiums may actually impede adaptation behavior.
- Skees, J.R., B.J. Barnett, and A.G. Murphy. Spring 2008. "Creating Insurance Markets for Natural Disaster Risk in Lower Income Countries: The Potential Role for Securitization." Agricultural Finance Review 68:151-167.
While significant progress in microcredit and microfinance has been made in low-income countries, lending for small farming enterprises has been limited. This article reviews how innovative index-based risk-transfer products (IBRTPs) can be used to transfer the correlated natural disaster risks that often hamper the development of farm-level microcredit.
