Relative Impacts of Hedging, Crop Insurance, and Government Programs
We consider four major cases, $0.017 vs. $0 hedging transaction cost, paired with 0%
and 30% insurance premium loadings respectively, as shown in Table 5 and 6. Under each case,
we set the base portfolio scenario as a full set of futures contract, crop insurance, and all three
government programs (DP, LDP, CCP). Then from the base scenario, we reduce one instrument
at a time to study the marginal effect of that instrument.
We design five risk management portfolios for the farmer. In addition to the optimal
hedge ratios and crop insurance ratios, we also compute a CE using equation (5). CE serves not
only as a measurement of welfare improvement, but also as a criterion to assess the relative
effectiveness of the tools to the farmer.
We start with the most complete set of risk management tools. In the base scenario with
a $0.017/bushel transaction cost (Table 5, upper panel), optimal hedge ratios range from 25% to
32% over years. The CE of this full portfolio is $62.28, the highest among all portfolios. As we
decrease the availability of government programs by taking away CCP first and then LDP, hedge
ratios generally increase from around 30% to 40% to around 60% to 75%, to cover the extra risk.
Correspondingly, without the support of CCP and LDP, the CE of the portfolios also decreases a
lot by more than 50% from $62.28 to $34.58. When the DP is also eliminated, hedge ratios
increase very slightly instead, which is due to the farmer’s tightened budget on transaction costs.
Without any government payments, the farmer has less wealth and is not willing to pay the
futures transaction cost. There is a different result for the scenario when there is no transaction
cost (Table 5, lower panel). The hedge ratios are about the same with or without the DP.
27