Progress 10/01/06 to 09/30/09
Outputs
OUTPUTS: The outputs under this project include numerous new methods of dealing with weather risk management in agriculture, new credit instruments for farmers, and advances in understanding stochastic processes. New initiatives related to weather risk management include the mathematical design and empirical valuation of wealther-linked credit instruments. These instruments link the repayment of various credit types (bonds, lines of credit and mortgages) to underlying weather risks (e.g. drought). Similar work under this project has been done on linking commodity prices to credit. These structured products have been applied to dairy farms in NY (credit insurance based on the price of milk) and in India (based on the prices of pulse crops). Other work under this project includes a better understanding of random walks in commodity prices. In particular I have developed a technique for determining whether a price series is consistent with a Brownian motion (i.e. random walk) or a fractional Brownian motion (not random, but predictable). This work has led to original explorations in wavelets and more recently into the mathematical definition of a unit root in autoregressive processes. In turn this work has, for the first time, the application of Ito excursions to financial (commodity prices) data. Original research has also focused on the market price of risk, which is an integral concept in financial economics. We have shown theoretically and empirically for the first time that the market price of risk is linked to the concept of market risk aversion. This is critical to the understanding and pricing of derivatives in general and non-traded risks (such as weather and stochastic volatility) in particular. Research is ongoing in a number of areas including developing risk contingent credit using dairy options to reduce business and financial risks for New York Dairy farmers. Examination of joint weather risk probabilities and basis risk assessment for the valuation of weather insurance. Advancing work on stochastic processes including fractional Brownian motion and wavelettes. Evaluating hedging strategies for corn and livestock producers in Mexico Evaluating hedging strategies for soybean processors in Phillipines PARTICIPANTS: Not relevant to this project. TARGET AUDIENCES: Farmers Risk Managers Agricultural Lenders Agricultural Policy Farm Managers Insurance companies PROJECT MODIFICATIONS: Not relevant to this project.
Impacts
The most significant and practical outcomes of this research is the development of what we refer to as risk contingent credit instruments. Risk contingent credit refers to a credit instrument with a payoff that is dependant on one or more underlying risks (e.g weather or the price of class III milk). Practical applications have been developed for New York dairy farmers. We show in the case of New York dairy farmers that by linking the payoff on lines of credit and farm mortgages to the price of milk is equivalent to direct insurance against the debt repayment ratio. That is the debt repayment ratio will always be equal to 1.0 in milk price risks. We show that the cost of this insurance can be high or modest depending upon how much financial risk the farmer is willing to bear. Other aspects of this research project are of a more theoretical nature with outcomes and impacts most clearly defined for academics in agricultural and financial economics.
Publications
- Escalante, Cesar L., Calum G. Turvey, Peter J. Barry (2009) Farm business decisions and the sustainable growth challenge paradigm Agricultural Finance Review 69(2).228-247
- Power, GJ and CG Turvey (2009) Long-run Resource Prices: A Wavelette Approach. Empirical Economics Letters
- Power, GJ and CG Turvey (2009)Long-Range Dependence in the Volatility of Commodity Futures Prices: Wavelet-Based Evidence. Physica A: Statistical Mechanics and its Applications
- Power, GJ and CG Turvey (2008) On the Exit Value of a Forward Contract. The Journal of Futures Markets Power, GJ and CG Turvey (2009) .Long-Run Trends in Natural Resource Prices, Evidence Across Time Horizons. Empirical Economics Letters
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Progress 10/01/07 to 09/30/08
Outputs
OUTPUTS: We have completed in 2008 the key algorithms in our weather risk management computer program at www.weatherwizard.us. We have added algorithms to investigate basis risk, that is the risk differential between a weather event at a weather station and a proximate location without a weather station. We have ammended the program to investigate weather related plant disease risks that are based on joint weather outcomes. We are continuing research into certain aspects of financial engineering and stochastic process. Doctoral students are investigating the economic properties of the market price of risk and the use of wavelettes to investigate underlying risks of a brownian motion. Our investigation into risk contingent credit for weather-linked credit and commodity-linked credit is now complete. Beneficiaries include academics and risk managers including the USDA and the Risk Management Agency PARTICIPANTS: Gabriel Power, Assitant Professor, Texas A&M University Qian Han, PhD Candidate, Applied Economics and Management, Cornell University Paitoon Wongsasutthikul, PhD Student, Applied Economics and Management, Cornell University Michael Norton, MS Student (defended 2008), Applied Economics and Management, Cornell University. Jeffrey Stokes, Associate Professor, The Pennsylvania State University TARGET AUDIENCES: Risk Managers Financial engineers Commercial banks and the farm credit system Insurance providers PROJECT MODIFICATIONS: Nothing significant to report during this reporting period.
Impacts
We have shown that we can create new financial products that imbed certain types of insurance into a credit instrument such as an operating loan, farm mortgage, or bond. We have shown that the maximum distance of correlated weather risk measurements from a weather station is about 12 miles. This result is important as it imposes a constraint on the functionality of weather insurance. We recommend that portable weather stations be used to best measure localized weather conditions and risk. We have shown that wavelette forms can be used to isolate risk factors in prices and believe that we can use wavelettes to identify underlying influences in commodity prices. We believe at this time that the technique can be used to identify insider trading and other market anomalies including bubbles. Forensic finance is a possibility.
Publications
- Power, GJ and CG Turvey (2008/9) Long-run Resource Prices: A Wavelette Approach Empirical Economics Letters , forthcoming,
- Power, GJ and CG Turvey (2008) U.S. Rural Land Value Bubbles Applied Economic Letters October
- Power, GJ and CG Turvey (2008) On the Exit Value of a Forward Contract The Journal of Futures Markets, Vol. 28, No. 8, 1,18
- Power, GJ and CG Turvey (2009) .Long-Run Trends in Natural Resource Prices: Evidence Across Time Horizons. Empirical Economics Letters forthcoming
- Turvey, C.G and J. Stokes (2008) .Market Structure and the Value of Agricultural Contingent Claims. Canadian J. Agric Econ. March
- Turvey, C.G. and M. Norton (2008) An Internet-Based Tool for Weather Risk Management J. Ag and Res. Econ. Spring 2008
- Turvey, C.G. (2008) The Pricing, Structure and Function of Weather-Linked Bonds, Mortgages and Operating Credit Agricultural Finance Review 68(1)
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Progress 10/01/06 to 09/30/07
Outputs
OUTPUTS: Activities This project is proceeding well on two separate fronts related to the objectives of risk contingent credit. First development has continued on the internet based weatherwizard program at www.weatherwizard.us. This program has been developed in the past year to investigate weather risks at USA weather stations. Activities in the past year include new algorithms to determine up to 5 joint heat and precipitation events, linkages to Google Earth and a basis (spatial risk measurement) algorithm. The model has been used to investigate risk contingent credit instruments based on weather risk management. The specific credit instruments include weather-linked bonds, weather-linked mortgages and weather-linked operating credit. In addition the models have been applied to examine the idea of weather-linked famine bonds for developing and famine prone countries. Work has also progressed for commodity-linked credits. One thesis has been completed applying, in full, the
concepts to pulse crops in India. It works very well and the products can much more easily be applied to US situations. Products The two key products are the internet software weatherwizard and www.weatherwizard.us and the development and application of a series if new mathematical formulas defining the credit instruments.
TARGET AUDIENCES: Agricultural lenders Microfinance institutions Risk Management Agency USDA
Impacts
The outcomes of this research are yet to be determined as a practical matter. From the current research we have determined that the methods developed under this project work, from an empirical point of view, to balance business and financial risks in agriculture. It is envisioned that a new class of financial instruments can be developed using the formulas and methods developed, that will reduce loan payments to farmers under certain conditions related to commodity or weather related price risk. Our formulas determine precisely the interest rate charged on a loan for this risk protection. These can be applied to USA agriculture as well as to financing in developing countries. The target audience is comprised of agricultural lenders and integrators such as investment bankers or hedge funds.
Publications
- Turvey, C.G. 2007. A Note on Scaled Variance Ratio Estimation of the Hurst Exponent with Application to Agricultural Commodity Prices. Physica A 377 (1) 155,165.
- Turvey, C.G. and M. Norton. 2008. An Internet-Based Tool for Weather Risk Management. J. Ag and Res. Econ. Spring 2008
- Kong, R and C.G. Turvey. 2007. Risk Trust and Micro Credit. Journal of Rural Economy October (Chinese).
- Chantarat S., C.B. Barrett, A.G. Mude and C.G. Turvey. 2007. Using Weather Index Insurance to Improve Drought Response for Famine Prevention. American Journal of Agricultural Economics, 89(5):1262,1268.
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Progress 01/01/06 to 12/31/06
Outputs
This research is in its first year. The activities this year have involved developing the economic insights and developing the mathematical formulas for determining the value and properties of risk contingent credit instruments. These instruments are financially engineered products that link the repayment of farm debt to the risk of either a weather variable or commodity price risk. The main theoretical work has been completed. In this first year this will be applied to two significant problems. In Africa, we will adapt the ideas to develop famine linked bonds, and in India we will apply the model to new forms of micro credit that are linked to the price of commodities (pulse crops). In China investigation will take place for both weather and commodity price risk management tools. This focus on development was discussed in the project proposal. We believe that these ideas and concepts are not only applicable to US agriculture and agribusiness, but also for risk
management in developing countries. Interest is very high. We will be presenting these ideas as keynotes at the American Agricultural Economics Association meeting in Portland Oregon in July 2007, and at a conference on climate change and risk management in Berlin. Interest in China, India and Africa is sufficiently high to warrant return travel and research. The credit instruments will be formally applied to the United States in 2007/2008. Already these concepts have been discussed with lenders and farmers in New York and a simple application using dairy options has been developed. Interestingly we find that the interest rate on these risk contingent products is only 1 per cent to 3 per cent higher than market interest rates, indicating that such instruments can be quite affordable. Finally, the proposal also calls for research into the nature of risk and how it affects capital acquisition in agricultural business. Preliminary research and a draft paper have been completed and
results will be presented at an International Symposium in Austria.
Impacts
This research will provide new financially engineered products at reasonable cost to farmers in the USA and in developing economies. The products being researched are innovative and are designed specifically to balance business and financial risk. The economic consequences are to increase agricultural productivity and investment, stimulate growth, increase access to debt capital, and in developing economies reduce poverty and environmental decay brought about by inneficient credit allocation.
Publications
- Turvey, C.G. 2006. A Brief History of the U.S. Farm Credit System with some thoughts about credit reform in China. Paper presented, Nanjing Agricultural University, Nanjing China, July 7
- Turvey, C.G. 2006. A Brief History of the U.S. Farm Credit System. Paper presented, Northwest University of Agriculture and Forestry, Xian China, July 13
- Turvey, C.G. and Chantarrat, S. 2006. Weather Linked Bonds. Paper Presented at the Annual NC1014 Regional Research Meeting, Washington DC, October 2-3 (repeated at the National Taiwan University, Taipei and China Agricultural University, November 2006)
- Turvey, C.G. and Chantarrat, S. 2006. Weather Linked Famine Bonds. Paper Presented at the International Food Policy Research Institute (IFPRI) Washington DC, October 3
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