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Crop Yield and Price Distributional Effects on Revenue Hedgingl

Viswanath Tirupattur, Robert J. Hauser and Nabil M. Chaherli2

Crop producers face both price risk and yield risk. Producers use futures and options
markets directly, as well as indirectly through secondary contracts offered by grain
merchandisers. However, similar private-sector instruments for managing output risk have not
been commonly available. On the other hand, federal agricultural support programs such as
deficiency and non-recourse loan programs as well as subsidized crop yield insurance programs
have provided output risk management mechanisms. In June 1995, a private-market alternative
for production and income stabilization became available in the form of new crop yield futures
and options.

Corn yield futures and options began trading at the Chicago Board of Trade (CBOT) in
June 1995 on the basis of the USDA reported estimate of the average state yield in Iowa. The
value of the contract is the traded yield (in bushels) times $100. There were two expiration
months -- September and January -- when the contract is cash settled based on the USDA
September and January corn yield reports. In 1996, additional corn yield contracts were added
on the basis of Illinois yield, Indiana yield, Ohio yield, Nebraska yield, and U.S. yield.
Additional expiration months were also specified.

The use of yield contracts for hedging production is often discussed in one of two
contexts. The first context involves the direct use of the contract by the producer. The second
context involves the indirect use by the producer through either, for example, elevators offering a
forward contract or through insurance companies offering revenue or production insurance.
Indeed, the yield contract is often referred to as a "yield insurance contract".

The general purpose of the present analysis is to provide insight into the potential effects
of using the yield futures contract in conjunction with the price futures contract on the expected-
revenue distribution facing the producer. The model reflects the expectation of revenue to be
realized by an Illinois corn and soybean producer making planting decisions in March. The
effects of using price and yield contracts are measured by comparing the resulting expected
distribution to the expected distribution found under five general alternatives: (1) a revenue
hedge using just price futures, (2) a revenue hedge using just yield futures, (3) a no-hedge
scenario where revenue is determined by realized price and yield, (4) a no-hedge scenario where
revenue is determined by the market and by participating in the former deficiency-payment
government support program, and (5) a no-hedge scenario where revenue is determined by the
market and by participating in a hypothetical revenue-assurance government support program.

1An earlier version of this paper appears in the 1995 Proceedings of the NCR-134
Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.

2The authors are Quantitative Research Analyst, Lincoln Investment Management, Inc.;
Professor and Interim Head, Department of Agricultural Economics, University of Illinois at
Urbana-Champaign; and Policy Economist, International Food Policy Research Institute,
respectively.



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