premiums, the expected return from participating in the insurance program is still higher than the
cost. Accordingly, it is beneficial to buy insurance at 85% rather than any lower coverage level.
In summary, the impact analysis of market institutions shows that farmers are more
responsive to the changes in transaction cost than in insurance premium. But the responsiveness
in hedge ratios to transaction cost is relatively small, indicating hedging might not be a major
consideration in farmers’ risk management decisions. Our representative farmer would always
choose to purchase insurance at the highest level 85%. Apparently the expected return due to
crop insurance premium subsidies covers the expenses due to premium loading up to 30%.
Impacts of Government Price Protection: Target Price and Loan Rate
Apart from hedging, government programs also contain elements of market price
protection. Base on values of the parameters for the target price (PT) and loan rate (LR) relative to
the expected market price, farmers receive price protection. Here we study the impacts of these
two parameters by changing their values hypothetically, while keeping the expected cash price
based on simulated distribution fixed for the next five years.
The impacts of these two parameters based on base model optimization are combined in
one graph as shown in Figure 9. The graph shows how optimal hedge ratios change as the
government protection level varies over the next five years. The process of combining the
impacts works as follows. First, when the target price changes from the current level of
$3.92/bushel down to $2.86/bushel, the loan rate remains at $2.86/bushel. Therefore, the price
range from $3.92 to $2.86 on the horizontal axis represents impacts from reducing the CCP’s
target price. When the target price drops below $2.86, the CCP actually has a zero value and no
longer plays a role in hedging decision. Thereafter, the loan rate varies from $2.86 to $0,
reflecting a decreasing level of protection from the LDP. When the loan rate finally reaches $0,
25
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