Source: UNIVERSITY OF ARKANSAS submitted to
COMMODITY VOLATILITY AND RISK MANAGEMENT
Sponsoring Institution
National Institute of Food and Agriculture
Project Status
TERMINATED
Funding Source
Reporting Frequency
Annual
Accession No.
0227106
Grant No.
(N/A)
Project No.
ARK02323
Proposal No.
(N/A)
Multistate No.
(N/A)
Program Code
(N/A)
Project Start Date
Oct 1, 2011
Project End Date
Oct 1, 2016
Grant Year
(N/A)
Project Director
Mckenzie, A.
Recipient Organization
UNIVERSITY OF ARKANSAS
(N/A)
FAYETTEVILLE,AR 72703
Performing Department
Agricultural Economics & Agribusiness
Non Technical Summary
Volatility in commodity markets affects all actors in the food system. Developing countries in Asia are particularly vulnerable to increased price volatility in rice, which is the staple food in the region and accounts for a large proportion of consumer income and expenditures. A lack of market-based tools, such as futures and options markets in Asian countries make the issue of increased volatility even more problematic. An objective of this proposed research is to evaluate the feasibility of developing and introducing a variety of market-based risk management tools for this region. Accomplishing the objectives of this project will provide a better understanding of commodity price volatility. This research effort will help guide academiciansAE future research efforts in this field and will enhance the ability of US and developing countriesAE farmers and agribusinesses to understand, manage, and forecast marketplace volatility. Given increased market volatility faced by agribusinesses, it is of prime importance to gain more understanding about the relative cost associated with options hedging. The cost of hedging using out-of-the money options is an implicit artifact of volatility skew patterns. Thus a natural question to be addressed is: do hedging pressures in commodity options markets, which may be related to industry concentration characteristics, induce more expensive risk management strategies for certain market participants For example, Thomsen and Mckenzie (2010) provide systematic evidence that buying out-of-the money live cattle puts is an expensive risk management strategy. In other words, real world put options prices are relatively more expensive than would be consistent with theoretical options pricing models. Another trend is increasing globalization and corresponding changes in domestic policy. Over the last decade a combination of greater liberalization of international trade policy and reduced US government intervention in commodity markets has propelled the US grain and oilseeds industries into a more market-oriented economic environment. Thus globalization can be seen as a driving force behind greater price risk and increased competition that is now facing US agriculture. A major advantage that US agriculture has over foreign competition is ease of access to developed commodity risk management markets. In order to remain competitive, US agribusinesses increasingly rely on options markets, which developed alongside the futures markets, to provide a cost-effective yet profitable service to market participants throughout the world. In addition to providing important business and marketing tools, options facilitate the price discovery process by serving as important benchmarks in negotiations between buyers and sellers. This role is central to the long-term efficiency and viability of US agriculture and an understanding of the behavior of these markets and how they have changed over time is crucial to decision makers in government, industry, and on the farm.
Animal Health Component
(N/A)
Research Effort Categories
Basic
(N/A)
Applied
(N/A)
Developmental
(N/A)
Classification

Knowledge Area (KA)Subject of Investigation (SOI)Field of Science (FOS)Percent
60362993010100%
Knowledge Area
603 - Market Economics;

Subject Of Investigation
6299 - Marketing, general/other;

Field Of Science
3010 - Economics;
Goals / Objectives
The objectives of this proposal are focused on analyzing the effect of increased commodity price volatility on Arkansas, US and world markets, and determining the effectiveness of market-based tools to manage associated risk. These objectives are further broken down as: 1. Further the understanding of commodity price volatility behavior with respect to US markets and food security of developing countries. 2. Analyze the informational role played by commodity futures and options markets, and the informational content of USDA crop and livestock reports. 3. Develop risk management strategies using futures and options to aid in the marketing of Arkansas produced commodities.
Project Methods
Initial plans are to prepare datasets for corn, soybeans, live cattle, and live/lean hogs. As the project unfolds, the intention is to include additional commodities, depending on findings and research direction. However, these four commodities represent the most actively traded agricultural commodities. Also, they enable a distinction to be made between storable and non-storable commodities and facilitate analysis of research topics that may be unique to each. Implied volatilities (IVs) will be computed from premiums for options across all traded strike prices. This involves choosing a theoretical pricing model and then solving for the volatility that equates the model formula with the observed, market-determined option premium. In general, there is not an analytical solution for volatilities but iterative search procedures are readily available that can be used to find solutions. Surveys of and interviews with rice industry participants and futures exchanges will be conducted to analyze the potential of market-based tools such as futures, options and swap markets to mitigate the negative impacts of price volatility in developing countries. Hedging effective methods will also be used to determine likely success of derivative innovation in emerging markets. In addition, time series techniques will be employed to determine dynamic and spatial market price relationships between futures and cash prices across trade regions. An innovative modeling approach, first used by McKenzie and Holt to explore the price discovery role of commodity futures prices in the US broiler market, will be used to analyze the informational content of USDA crop reports. An enduring issue in commodity market analysis has been the manner in which agents incorporate information to form price and production expectations. McKenzie and Holt's approach is unique as it recognizes that a combination of informational sources may more accurately reflect agents' true price and production expectations. Econometric and time series models will be estimated to derive optimal hedging ratios for various agricultural operations. Time series models using GARCH processes will be used to obtain optimal time-varying hedge ratios. Also, simulation techniques will be employed to measure relative effectiveness of different marketing contracts offered by grain elevators.

Progress 10/01/11 to 10/01/16

Outputs
Target Audience: Nothing Reported Changes/Problems: Nothing Reported What opportunities for training and professional development has the project provided? Nothing Reported How have the results been disseminated to communities of interest?Publications. What do you plan to do during the next reporting period to accomplish the goals? Nothing Reported

Impacts
What was accomplished under these goals? Research related to the price transmission of wholesale to retail Bangladesh rice prices was analyzed. Our results showed that wholesale and retail prices are cointegrated (move together over time), and wholesale market plays a leadership role in determining retail prices, which is in line with industrial organization theory. Our results confirm the fear and concerns of consumers about the existence of price asymmetry. In other words retail prices rise in line with increases in wholesale price but retail prices don't fall to the same extent when wholesale prices decrease. Research was conducted to determine the value of the U.S. rice futures market and supply and demand information published by the U.S. Department of Agriculture (USDA) to the U.S. rice marketing system. Results shows that the USDA provides the futures market with important information, which is vital to the price discovery process. In an era of declining federal budgets, it is important to provide economic justification for the continued publication of USDA reports. Our results undoubtedly show that USDA reports play a vital role in helping futures market to discover price and that this is particularly important for the U.S. rice market, where there is a paucity of private data and forecast to supplement government numbers. Also, the lack of interim private rice forecasts suggests that there is an information gap between USDA reports. The information gap is an opportunity that could be profitably exploited by private firms that could provide accurate and timely forecasts of monthly USDA numbers and final production numbers released in January. This, of course, begs the question as to why this private information does not currently exist. We speculate that this is a classic "chicken and egg" situation, where lack of private information may be attributed to low trading volume in rice futures and low trading volume is perhaps partly explained by a lack of private information. An important future research question to address is to identify all of the potential factors that might be contributing to low trading volume in U.S. rice futures contract.

Publications

  • Type: Journal Articles Status: Awaiting Publication Year Published: 2017 Citation: McKenzie A. M. and Darby, Jessica L. Information Content of USDA Rice Reports and Price Reactions of Rice Futures.Agribusiness an International Journal
  • Type: Journal Articles Status: Published Year Published: 2016 Citation: Mohammad Jahangir Alam, A.M. McKenzie, Ismat Ara Begum, Jeroen Buysse, Eric J. Wailes and Guido Van Huylenbroeck. Asymmetry Price Transmission in the Deregulated Rice Markets in Bangladesh: Asymmetric Error Correction Model. Agribusiness an International Journal


Progress 10/01/14 to 09/30/15

Outputs
Target Audience: Nothing Reported Changes/Problems: Nothing Reported What opportunities for training and professional development has the project provided? Nothing Reported How have the results been disseminated to communities of interest? Nothing Reported What do you plan to do during the next reporting period to accomplish the goals? Nothing Reported

Impacts
What was accomplished under these goals? A better understanding of how rice market volatility impacts margins between wholesale and retail markets in Bangladesh. A better understanding of how rice futures prices react to USDA report information.

Publications

  • Type: Journal Articles Status: Published Year Published: 2015 Citation: Alam, M. J., J. Buysse, A.M. McKenzie. "Asymmetry Price Transmission in the De-regulated Rice Markets in Bangladesh: Asymmetric Error Correction Model" Agribusiness: an International Journal, in press Song Liu, Tingfei Tang, A. M. McKenzie, and Yibin Liu. Low-Frequency Volatility in Chinas Gold Futures Market and Its Macroeconomic Determinants. Mathematical Problems in Engineering, May 2015. Darby, Jessica L., and A. M. McKenzie. Information Content of USDA Rice Reports and Price Reactions of Rice Futures. Inquiry, 2015, Vol 2, p5-13.


Progress 10/01/13 to 09/30/14

Outputs
Target Audience: US farmers, grain elevators, and rice farmers Changes/Problems: Nothing Reported What opportunities for training and professional development has the project provided? Dr. McKenzie's expertise in futures and options markets was recognized by CFARE when he was invited to present a hands-on workshop covering the fundamentals of agricultural futures and options for congressional staff of all Members of the House Committee on Agriculture on Tuesday, January 28 2014. How have the results been disseminated to communities of interest? Nothing Reported What do you plan to do during the next reporting period to accomplish the goals? Results from theco-operative grant work will be presented at NCCC-134 "Applied Commodity Price Analysis, Forecasting and Market Risk Management" conference in St. Louis, April 2015. Furthermore, McKenzie and Thomsen submitted an AAEA invited paper session proposal for 2015 AAEA meetings in San Francisco July-Aug 2015, titled "What Drives Uncertainty and Volatility in Agricultural Markets?"

Impacts
What was accomplished under these goals? Dr. McKenzie has 3 peer reviewed journal articles under review stemming from his research collaboration with a visiting scholar from China, Song Liu (Southern China Agricultural University). Dr. McKenzie and Dr. M. Thomsen secured a co-operative grant from USDA Office of the Chief Economist to analyze commodity price volatility using intra-day CME futures data.

Publications


    Progress 01/01/13 to 09/30/13

    Outputs
    Target Audience: US farmers, grain elevators, and rice farmers Changes/Problems: Nothing Reported What opportunities for training and professional development has the project provided? Nothing Reported How have the results been disseminated to communities of interest? Nothing Reported What do you plan to do during the next reporting period to accomplish the goals? Analyze high frequency options and futures pricing data around importand agricultural commodity market events such as USDA reports

    Impacts
    What was accomplished under these goals? Live cattle Options markets were found to contain information about price expectations related to BSE. A greater understanding of dynamic price relationships between corn, ethanol and cruder oil markets were uncovered.

    Publications

    • Type: Journal Articles Status: Published Year Published: 2013 Citation: Thomsen, M.R., A.M. McKenzie, and G. Power. Was there a Peso Problem in Cattle Options? Evidence from the 2003 Bovine Spongiform Encephalopathy Announcement. Agricultural Finance Review 2013 Vol73 Issue 3, 526-538. Natenalov, V., A. M. McKenzie, and G. Van Huylenbroeck. Crude Oil  corn  ethanol nexus : a contextual approach. Energy Policy Vol. 63.December 2013, Pages 504513.
    • Type: Book Chapters Status: Published Year Published: 2013 Citation: Timothy E. Zimmer, Valerien O. Pede, and Andrew M. McKenzie. Valuing Risk Exposure and the Expected Cost of Margin Calls: The Case for a Secondary Market in Redistributing Liquidity Liability (Margin Credit Swaps). Business Review: Advanced Applications.


    Progress 01/01/12 to 12/31/12

    Outputs
    OUTPUTS: Three Masters Theses commodity risk management topics were initiated. Specifically, returns to storing hedged corn and soybeans were analyzed; risk return characteristics of farmer-elevator marketing contracts were assessed; and the potential for developing an Asian based rice futures contract was evaluated. Work was also conducted on measuring the transmission of shocks in world rice prices to Bangladeshi rice markets. PARTICIPANTS: Not relevant to this project. TARGET AUDIENCES: US farmers, grain elevators, and Asian governments and rice farmers PROJECT MODIFICATIONS: Not relevant to this project.

    Impacts
    The contracting research impacts include a better understanding, from the point of view of farmers, of the potential price risks and profitability of entering into different marketing contracts. The storage research shows that storing corn and soybeans without hedging does not generate consistently higher returns than selling crops at harvest time. The Asian futures market research indicates that Asian economies cannot currently support a rice futures contract.

    Publications

    • Alam, M. J., J. Buysse, A.M. McKenzie, E. J. Wailes, and G. Van Huylenbroeck. "The Dynamic Relationship between World and Domestic Prices of Rice under the Regime of Agricultural Trade Liberalization in Bangladesh." Journal of the Asia Pacific Economy Feb 2012, Vol. 17 Issue 1, p113-126
    • Mckenzie, A.M., "Prefeasibility Study of an ASEAN Rice Futures Market." Asian Development Bank Sustainable Development Working Paper Series, No. 19, March 2012.
    • Mckenzie, A.M "Potential Risk Management Benefits of Rice Futures Markets for developing countries - lessons from the US." World Bank FARMD Forum for Agricultural Risk Management and Development 2012