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Evaluating Risk Management
Tools for Agribusiness: A
California Perspective
Palisade 2012 Risk Conference – Las Vegas, NV – November 7 & 8
Mark Manfredo, Ph.D Morrison School of Agribusiness and Resource Management
College of Technology and Innovation
Arizona State University
overview
background
Calif. ag risk
environment
case study
random
thoughts
background: my experience with @RISK
consider financial variables with and without the use of active risk management
In @RISK examine output distributions with and
without risk management
California Agriculture Risk Management Conference, Sacramento, CA May 18, 2012
• Conference sponsored by Cal Poly SLO and Farm
Credit West.
• Objective was to inform agribusinesses and their
lenders on issues of risk management.
California ag risk environment: a cornucopia of risks
tremendous value &
diversity of California
agriculture
More than 350 commercial crop and livestock
commodities produced in California.
numerous factors that impact prices and yields and ultimately revenue or costs
no “cookie cutter” approach for risk management in CA agribusiness
Diversification, futures, options, cash forward contracts,
and insurance (crop insurance) – but not all available for
California’s diverse crop and livestock enterprises.
case study: navel oranges in Fresno County, CA
strategies simulated:
1. no risk management
2. forward contract
3. yield insurance
4. forward w/ yield insurance
5. revenue insurance
Focus on the resulting distribution of per acre
revenue (price x yield)
risk measurement -
uncertainty of outcomes
vs. just bad outcomes?
Risk managers and academics alike consider both the
uncertainty of outcomes (good and bad) and probability of
bad outcomes when measuring risk
therefore best risk management scenario – reduce standard deviation, shift or truncate VaR, and increase mean
mean
5%
VaR = $20
VaR = $40
5%
No Risk Management
Risk Management
mean
Price Yield per Acre Revenue per Acre
Year ($/carton) (cartons) (price x yield)
1990 $5.04 290 $1,461.74
1991 $4.36 627 $2,730.46
1992 $3.16 768 $2,429.89
1993 $3.99 642 $2,559.71
1994 $3.91 594 $2,322.54
1995 $3.68 628 $2,311.04
1996 $4.68 646 $3,023.28
1997 $4.42 682 $3,014.44
1998 $5.23 324 $1,694.52
1999 $3.28 626 $2,053.28
2000 $4.99 546 $2,724.54
2001 $6.44 492 $3,168.48
2002 $3.99 627 $2,501.73
2003 $5.30 581 $3,079.30
2004 $4.91 638 $3,132.58
2005 $4.81 671 $3,227.51
2006 $5.67 489 $2,772.63
2007 $5.23 638 $3,336.74
2008 $6.70 490 $3,283.00
2009 $6.69 608 $4,067.52
Mean $4.82 580 $2,744.75
Std. Deviation $1.03 115.60 $607.09
Use “Distribution Fitting” to fit appropriate Price and Yield input distributions
Price ($/Carton) – Inverse Gaussian
Yield (Cartons) – Logistic
Revenue ($/ac) Draw 1: $5.04 x 290 = $1,461.60 Draw 2: $3.25 x 768 = $2,496 : : Draw 5000: $6.75 x 490= $3,307.50
Price ($/ctn) Draw 1 = $5.04 Draw 2 = $3.25 : : Draw 5000 = $6.75
Yield (ctn/ac) Draw 1 = 290 Draw 2 = 768 : : Draw 5000 = 490
correlation = -0.486
Examine risk measures of revenue with and without risk management
Monte Carlo Simulation
2. forward contract
Seller / buyer agree upon a fixed price to deliver (receive)
a given quantity of commodity at a later date. Remains a
popular tool for price risk management.
Forward Contract w/Rule
• forward contract taken if beginning of
season price > long-run average price of
$4.82
• rule necessary as routine forward contract
just yields average price in the long run
=if(I13>=H12,I13,I7)
3. yield insurance (APH)
Actual Production History (APH) – federally subsidized
yield insurance program sold through private crop
insurance agents and administered by USDA Risk
Management Agency.
actual production history (APH)
• basic formula:
yield guarantee = (APH yield x coverage level)
if actual yield < yield guarantee ; indemnity
indemnity = (yield guarantee – actual yield) x
price election
actual production history (APH)
• coverage level and price election are
major determinants of premium
• catastrophic risk protection (CAT) typically
lowest coverage level and price election
– premium 100% subsidized
APH – Average Production History
Premium = $144 per acre after subsidy Revenue per Acre = Price x Yield + Indemnity – Premium Example Adapted from 2013 RMA Commodity Fact Sheet, Citrus – APH
Per Acre Avg. Yield (APH) 596
Coverage Level Percentage 0.75
Yield per Acre Guarantee 447
Price Election $4.82
Example Indemnity
Yield per Acre Actually Produced (Actual Yield) 400
Yield per Acre Loss 47
Gross Indemnity Per Acre $226.54
(zero if actual yield > yield guarantee)
4. forward contract w/
yield insurance (APH)
Manages risk of both price and yield independently.
Forward Contract with APH
• Revenue = Forward Price x Yield +
Indemnity – Premium
5. revenue insurance
(ARH)
Actual Revenue History (ARH) – federally subsidized
revenue insurance program sold through private crop
insurance agents and administered by USDA Risk
Management Agency.
actual revenue history (ARH)
• basic formula:
revenue guarantee = (approved revenue x
coverage level x payment factor)
if actual revenue < revenue guarantee; indemnity
indemnity = (revenue guarantee – actual revenue)
actual revenue history (ARH)
• coverage level is major determinant of
premium
• catastrophic risk protection (CAT) typically
lowest coverage level
– premium 100% subsidized
ARH – Actual Revenue History Approved Revenue $2,876
Coverage Level 0.75
Payment Factor 1.00
Revenue Guarantee $2,157
Example Indemnity
Actual Revenue $1,500
Indemnity per Acre $657
(zero if actual rev > rev guarantee)
Premium = $176 per acre after subsidy Revenue per Acre = Price x Yield + Indemnity – Premium Example Adapted from 2013 RMA Commodity Fact Sheet, Citrus – APH
run the simulation: Monte Carlo – 5000 iterations
@RISK Simulation Results – Fresno County Navels
No Risk Mgt
Forward w/Rule
APH Forward / APH
ARH
Mean $2,878 $3,111 $2,756 $2,988 $2,760
Standard Deviation
$805
$810 $777 $780 $728
Coeff. of Variation
0.280 0.260 0.282 0.261 0.264
VaR(5%) $1,739 $1,867 $1,690 $1,816 $1,981
Minimum $541 $644 $1,034 $1,034 $1,981
1.74 +∞5.0% 95.0% 0.0%
0
1
2
3
4
5
6
0 1 2 3 4 5 6 7 8
Val
ues
x 10
^-4
Values in Thousands ($)
Revenue per Acre - No Risk management
1.981 +∞5.0% 95.0% 0.0%
0
0.000002
0.000004
0.000006
0.000008
0.00001
0.000012
0.000014
0.000016
0.000018
1.5 2
2.5 3
3.5 4
4.5 5
5.5 6
6.5 7
Values in Thousands ($)
Revenue per Acre - ARH
random thoughts: what was learned?
insights from simulation
and ensuing discussion
Risk management beneficial vs. no risk management
Virtues of insurance – revenue insurance shows
promise, but is it worth the premium?
Caveat – true risks may go beyond historical data
what is the best tool for
California agribusiness?
…it depends!
Major questions include the appropriateness of the tool
given the type of operation and risks that need to be
managed, knowledge and comfort level in using a given
tool, and appetite for risk.
THANK YOU!
Mark Manfredo, Ph.D. Morrison School of Agribusiness and Resource Management
College of Technology and Innovation
Arizona State University
480.727.1040
@AgriBizProf
Palisade 2012 Risk Conference – Las Vegas, NV – November 7 & 8