Income Enhancing and Risk Management Properties of Marketing Practices

WP 2001-06 June 2001A rational expectations storage model is used to simulate monthly corn prices, which are used to evaluate marketing strategies to manage price risk. The data are generated and analyzed in two formats: for long-run outcomes over 10,000 “years” of monthly prices and for 10,000 cases of 40-year “lifetimes.” Three categories of strategies are analyzed: frequency of post-harvest cash sales, unconditional hedges, and conditional hedges. The comparisons are based on the simulated probability distributions of net returns. One conclusion is that diversifying cash sales, without hedging, is not an efficient means of risk management. Unhedged storage does not reduce risk and, on average, reduces returns. The analysis of the 40- year lifetimes demonstrates, however, that rational decision-makers can face “lucky” and “unlucky” time periods. Thus, although the long-run analysis suggests that routine hedging reduces the variance (and the mean) of returns compared to the base case of selling in the spot market at harvest, the variance of returns (and their means) from both strategies will vary from lifetime to lifetime. Efficient strategies for producers with increasing utility functions vary from lifetime to lifetime, suggesting that efficient strategies likely vary from year-to-year. Nonetheless, strategies that take advantage of locking in returns to storage when relative prices are favorable are efficient in the second-degree sense and appear robust across different lifetimes. We also illustrate that conclusions are influenced by the measure of risk used. Perhaps the major conclusion is, however, that risk-management analysis is complex and potentially filled with pitfalls.We acknowledge financial support from USDA NRI Competitive Grants Award 99-35400-7796