The outcome from a study in USA states that when a producer combines a forward sale with the purchase of crop insurance, the probability of low revenue is reduced dramatically for each of the locations, compared with the no-strategy case. The cost-effectiveness of futures contract and options to protect farmers against price risks is contingent on yield variability, on the correlation between yield and price variability (natural hedge) and on the distance from markets. In case of high yield variability, production becomes less predictable, consequently a farmer may only hedge a small volume in order to avoid having to buy additional products to fulfill his futures contract in case of low yields. In this scenario, the hedge ratio, i.e. the optimal share of actual production to be hedged, and the risk reduction efficiency is low.
The need and acceptance of risk-hedging instruments depends on the strength of negative relationship between yield and price, called the “natural hedge”, for a particular commodity in a particular region. For instance, widespread low corn yields can cause prices to increase significantly. Conversely, low prices are often associated with bumper-crop years. This partially “offsetting” relationship between prices and yields tends to stabilize farm revenues over time. Yield and price variations are less likely to offset each other where the natural hedge is weak. In states such as North Carolina, low corn prices and low yields (or high prices and high yields) are more likely to occur at the same time than in the Corn Belt, making corn revenues inherently more variable. This is because these areas have less impact than the Corn Belt on national output and prices. Forward selling reduces revenue risk substantially in areas where the natural hedge is relatively weak.
The need and acceptance of risk-hedging instruments depends on the strength of negative relationship between yield and price, called the “natural hedge”, for a particular commodity in a particular region. For instance, widespread low corn yields can cause prices to increase significantly. Conversely, low prices are often associated with bumper-crop years. This partially “offsetting” relationship between prices and yields tends to stabilize farm revenues over time. Yield and price variations are less likely to offset each other where the natural hedge is weak. In states such as North Carolina, low corn prices and low yields (or high prices and high yields) are more likely to occur at the same time than in the Corn Belt, making corn revenues inherently more variable. This is because these areas have less impact than the Corn Belt on national output and prices. Forward selling reduces revenue risk substantially in areas where the natural hedge is relatively weak.
