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Crop Yield and Price Distributional Effects on Revenue Hedging

Abstract

The use of crop yield futures contracts is examined. The expectation being modeled here
reflects that of an Illinois corn and soybeans producer at planting, of revenue realized at harvest.
The effects of using price and crop yield contracts are measured by comparing the results of the
expected distribution to the expected distribution found under five general alternatives: 1) a
revenue hedge using just price futures, 2) a revenue hedge using crop yield futures, 3) an
unhedged scenario where revenue is determined by realized prices and yields, 4) an unhedged
scenario where revenue is determined by realized prices and yields and by participation in
government support programs with deficiency payments, and 5) a no hedge scenario where
revenue is determined by realized prices and yields and by participation in a proposed revenue-
assurance program.

We draw four major conclusions from the results. First, hedging effectiveness using the
new crop yield contract depends critically on yield basis risk which presumably can be reduced
considerably by covering large geographical areas. Second, crop yield futures can be used in
conjunction with price futures to derive risk management benefits significantly higher than using
either of the two alone.

Third, hedging using price and crop yield futures has a potential to offer benefits larger
than those from the simulated revenue assurance program. However, the robustness of the
findings depends largely on whether yield basis risk varies significantly across regions. Finally,
the qualitative results described by the above three conclusions do not change depending on
whether yields are distributed according to the beta or lognormal distribution.

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