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

givenα (α= -0.13) also affects attitudes towards risk and timing. The farmer’s preference
toward resolution of risk will change from late to early. Combined with the increasing
substitution effect of late consumption for early consumption, it can be seen that hedge ratios for
the first four years change relative to each other.

In summary, sensitivity analysis of intertemporal preferences shows that optimal
hedging behavior of the representative farmer is sensitive to intertemporal preferences change.
Risk aversion appears to have a larger effect on hedge ratios than time preference and
intertemporal substitutability. Each of the preferences seems to have a different pattern of impact.
But even in the separate analysis, the effect is often intertwined with influences from the other
preferences due to relative value changes among them.

Impacts of Market Institutions: Transaction Cost and Insurance Premium Loading

Transaction costs related to futures contracts and insurance premiums are the major
costs farmers pay for using hedging to reduce price risk and crop insurance to manage yield or
revenue risks. To examine how these institutions affect farmers’ risk management decisions, we
set up different levels for transaction cost and premium loading, while other parameters in the
model remain fixed. The impacts of transaction costs and insurance premium loading are studied
in detail based on the base model in this section. We also briefly discuss the impacts of these two
factors based on results from other EU-type models in a later section.

Transaction costs are what farmers must sacrifice from current income to receive future
market price protection if they choose hedging to reduce price risk. When transaction costs are
charged, hedging has offsetting impacts. More hedging improves farmers’ expected utility
through price risk protection, but it also reduces utility by directly lowering current consumption.
Using the base model where all tools are included, we first let transaction cost vary from

23

<<   22   23   24   25   26   27   28   >>

More intriguing information