Intertemporal Risk Management Decisions of Farmers under Preference, Market, and Policy Dynamics

shows an optimal strategy that is more consistent with reality on hedging and crop insurance for
the decision maker, who wants to maximize utility over the whole time span. The GEU model
framework is also flexible enough to account for separate risk, time, and substitution preferences,
and is able to incorporate other commonly used EU models that have either ignored
intertemporal substitution preference or integrated such substitution with risk preference.

VI. The Impacts of Preference, Market, and Policy Dynamics

For this part of analysis, we only focus on Whitman County wheat growers. Based on
the GEU maximization, we examine the impacts of risk aversion, time preference, and
intertemporal substitutability on farmers’ optimal choice of hedging and crop insurance
participation through parameterization of the preferences. By setting the price instruments with
futures contracts, insurance policies, and government payments at different levels, we examine
the impacts of market institutions. In addition, we investigate the relative impacts of each of the
major risk management tools through various ways of constructing a risk management portfolio.
These impacts are not only reflected in the optimal level of hedge ratios, but also in the cash
value associated with the choice.

In order to differentiate the impacts of intertemporal preferences from those of market
and policy alternatives, we consider two steps. First, assume the set of policy and market risk
management tools stays the same while farmer’s preferences vary, with the preferences changing
one at a time. Second, change the parameters related with hedging, crop insurance, and
government programs, for one tool at a time, when preferences are set at the base level.

Impacts of Preferences: Risk Aversion, Time Preference, and Intertemporal Substitutability

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