The 1995 Through 1998 Pricing Performance of Market Advisory Services
Mark A. Jirik, Scott
H. Irwin, Darrel L. Good,
Thomas E. Jackson, and Joao
2000 by Mark A. Jirik, Scott H. Irwin, Darrel L. Good, Thomas E. Jackson
and Joao Martines-Filho. All rights reserved. Readers may make verbatim
copies of this document for non-commercial purposes by any means, provided
that this copyright notice appears on all such copies.
advisory service marketing recommendations used in this research represent
the best efforts of the AgMAS Project staff to accurately and fairly interpret
the information made available by each advisory program. In cases where
a recommendation is vague or unclear, some judgment is exercised as to
whether or not to include that particular recommendation or how to implement
the recommendation. Given that some recommendations are subject to interpretation,
the possibility is acknowledged that the AgMAS track record of recommendations
for a given program may differ from that stated by the advisory service,
or from that recorded by another subscriber. In addition, the net advisory
prices presented in this report may differ substantially from those computed
by an advisory service or another subscriber due to differences in simulation
assumptions, particularly with respect to the geographic location of production,
cash and forward contract prices, expected and actual yields, carrying
charges and government programs.
The primary purpose
of this research report is to present an evaluation of advisory service
pricing performance for the 1995, 1996, 1997, and 1998 wheat crops. In
order to evaluate the returns to the marketing advice produced by the
services, the AgMAS Project purchases a subscription to each of the services
included in the study. The information is received electronically via
DTN, World Wide Web sites or e-mail. Staff members of the AgMAS Project
read the information provided by each advisory service on a daily basis.
A directory of the advisory services included in the study can be found
at the Agricultural Market Advisory Services
(AgMAS) Project website (http://web.aces.uiuc.edu/farmdoc/agmas/).
assumptions are made to produce a consistent and comparable set of results
across the different advisory programs. These assumptions are intended
to accurately depict “real-world” marketing conditions. Several key assumptions
are: i) with a few exceptions, the marketing window for wheat is June
1st of the year prior to harvest to May 31st of
the year following harvest, ii) cash prices and yields refer to a soft
red winter wheat producer in southwest Illinois, iii) all storage is assumed
to occur off-farm at commercial sites, and iv) loan deficiency payment
(LDP) recommendations made by advisory programs are followed wherever
feasible and applicable.
The average net advisory
price across all 24 wheat programs in 1995 is $3.79 per bushel, $0.18
above the market benchmark price. The range in 1995 is $3.01 to $4.71
per bushel. The average net advisory service price for 23 wheat programs
in 1996 is $3.82 per bushel, $0.13 below the market benchmark. The range
in 1996 is $2.74 to $4.94 per bushel. The average net advisory price
for all 20 wheat programs in 1997 is $2.64 per bushel, $0.58 below the
market benchmark. The range in 1997 is $1.34 to $3.90 per bushel. Finally,
the average net advisory price across all 21 services in 1998 is $2.36
per bushel, $0.54 below the market benchmark. The range in 1998 is $1.34
to $3.33 per bushel.
The average revenue
achieved by following the wheat programs over four years is $151 per acre,
$16 less than the four-year average market benchmark revenue. The spread
in advisory revenue also is noteworthy, with the difference between the
bottom- and top-performing advisory programs over four years reaching
nearly $40 per acre.
An advisory program’s
net price or revenue received is an important indicator of performance.
However, the tradeoff between pricing performance and risk is likely to
be of interest to producers. Based on the data available for 1995-1998,
a modestly negative tradeoff between average net advisory price and risk
is found; producing higher net prices generally requires that an advisory
program take on less risk, and vice versa. One advisory program
in wheat outperforms the market benchmark when both price and risk are
considered, while many have a lower price and higher risk. No program
outperforms the benchmark based on revenue. It is important to emphasize
that the pricing and risk performance results are based on only four observations.
This is a small sample for estimating the true risks of market advisory
programs. Hence, the return-risk results should be viewed as exploratory
rather than definitive.
to the AgMAS Project
Wheat producers operate
in a highly uncertain economic environment. The roller coaster movement
of wheat prices since 1995 is ample evidence of the uncertainty and risk
facing wheat producers. In this rapidly changing environment, marketing
and risk management play an important role in the overall management of
farm businesses. The use of private-sector advisory services has increased
over time as producer demand for marketing and risk management advice
has increased. Surveys document the high value that many producers place
on market advisory services.[2
Despite their current
popularity and expected importance in the future, surprisingly little
is known about the marketing and risk management strategies recommended
by these services and their associated performance. There is a clear
need to develop an ongoing “track record” of the performance of these
services. Information on the performance of advisory services will assist
producers in identifying successful alternatives for marketing and price
Market Advisory Services (AgMAS) Project, initiated
in the fall of 1994, addresses the need for information on advisory services.
Dr. Darrel L. Good and Dr. Scott H. Irwin of the University of Illinois
at Urbana-Champaign jointly direct the project. Correspondence with the
AgMAS Project should be directed to: Joao Martines-Filho, AgMAS Project
Manager, 434a Mumford Hall, 1301 West Gregory Drive, University of Illinois
at Urbana-Champaign, Urbana, IL 61801; voice: (217)333-2792; fax: (217)333-5538;
e-mail: firstname.lastname@example.org. The AgMAS project also has a website with the
following address: http://web.aces.uiuc.edu/farmdoc/agmas/.
Funding for the AgMAS
Project is provided by the following organizations: American Farm Bureau
Foundation for Agriculture; Illinois Council on Food and Agricultural
Research; Cooperative State Research, Education, and Extension Service,
U.S. Department of Agriculture; Economic Research Service, U.S. Department
of Agriculture; and the Risk Management Agency, U.S. Department of Agriculture.
Purpose of Report
The primary purpose
of this research report is to present an evaluation of advisory service
pricing performance for the 1995, 1996, 1997, and 1998 wheat crops. Specifically,
the net advisory price received by a subscriber to an advisory service
is calculated for wheat harvested in each of these years. With some exceptions,
the marketing window for each year is from June 1st of the
year prior to harvest through May 31st of the year following
harvest. The most important exceptions are due to two services that still
held all of the 1997 and/or 1998 wheat crops at the time the analysis
was conducted for this report. In order to complete the analysis for
these two services, futures positions and all remaining cash amounts are
marked-to-the-market as of May 31, 2000. Future AgMAS wheat pricing reports
will update and revise results for these two services when they make final
An important point
to consider is that the pricing results are available for only four marketing
periods. It is inappropriate to draw too many conclusions from four
crop years' results. A useful analogy is university yield trials
for crop varieties. In evaluating the results of crop yield trials, while
the results of the most recent year may be of particular interest, firm
conclusions about the relative merits of one variety versus another can
only be drawn after a number of years of results are available. The same
is true for market advisory services.
It is also important
to recognize that the performance results in this report emphasize the
pricing, or return, element of marketing and risk management. While certainly
useful, such results do not address the issue of risk. Two advisory services
with the same average net price, for example, may expose producers to
quite different risks. The final section of this report contains a “first
look” at the relationship between the wheat pricing performance and risk
of advisory services. Since the return-risk results are based on just
four years of data, the results must be viewed quite cautiously.
This report has been
reviewed by the AgMAS Review Panel, which provides independent, peer-review
of AgMAS Project research. The members of this panel are: Frank Buerskens,
Director of Product Strategy for e-markets; Renny Ehler, producer in Champaign
County, Illinois; Chris Hurt, Professor in the Department of Agricultural
Economics at Purdue University; Terry Kastens, Assistant Professor in
the Department of Agricultural Economics at Kansas State University and
producer in Rawlins County, Kansas; and Robert Wisner, University Professor
in the Department of Economics at Iowa State University
The next section
of the report describes the procedures used to collect the data on wheat
market advisory service recommendations. The second section of this report
describes the methods and assumptions used to calculate the returns to
marketing advice. The third section presents the year-by-year overview
of 1995, 1996, 1997, and 1998 pricing results for wheat. The fourth section
presents a summary of the combined results for the 1995, 1996, 1997, and
1998 crop years. The final section presents initial results on the tradeoff
between pricing performance and risk of market advisory services in wheat.
The market advisory
services included in this evaluation do not comprise the full population
of market advisory services available to wheat producers. The included
services also are not a random sample of the population of market advisory
services. Neither approach is feasible because no public agency or trade
group assembles a list of advisory services that could be considered the
"population." Furthermore, there is not a generally agreed
upon definition of an agricultural market advisory service. To assemble
the sample of services for the AgMAS Project, criteria were developed
to define an agricultural market advisory service and a list of services
The first criterion
used to identify services is that a service has to provide marketing advice
to producers. Some of the services tracked by the AgMAS Project do provide
speculative trading advice, but that advice must be clearly differentiated
from marketing advice to producers for the service to be included. The
terms "speculative" trading of futures and options versus the
use of futures and options for "hedging" purposes are used for
identification purposes only. A discussion of what types of futures and
options trading activities constitute hedging, as opposed to speculating,
is not considered.
The second criterion
is that specific advice must be given for making cash sales of the commodity,
in addition to any futures or options hedging activities. In fact, some
marketing programs evaluated by the AgMAS Project do not make any futures
and options recommendations. However, marketing programs that make futures
and options hedging recommendations, but fail to clearly state when cash
sales should be made, or the amount to be sold, are not considered.
A third, and fairly
obvious, criterion is that the advice must be transmitted to subscribers
before the action is to be taken. This is largely the reason that only
electronically delivered services are evaluated.
The original sample
of market advisory services that met the three criteria was drawn from
the list of "Premium Services" available from the two major
agricultural satellite networks, Data Transmission Network (DTN) and FarmDayta,
in the summer of 1994.,  While the list of advisory
services available from these networks was by no means exhaustive, it
did have the considerable merit of meeting a market test. Presumably,
the services offered by the networks were those most in demand by farm
subscribers to the networks. In addition, the list of available services
was crosschecked with other farm publications to confirm that widely followed
advisory firms were included in the sample. It seems reasonable to argue
that the resulting sample of services was (and remains) generally representative
of the majority of advisory services available to producers.
The total number
of advisory programs evaluated for at least one of the four marketing
years is 27, of which 18 are followed for all four years. The term “advisory
program” is used because several advisory services have more then one
distinct marketing program. Ag Line by Doane, Agri-Edge, Brock Associates,
Pro Farmer, and Stewart-Peterson Advisory Services each have two distinct
marketing programs, and Agri-Visor has four distinct marketing programs.
For a variety of
reasons, additions and deletions to the sample of wheat advisory programs
has occurred over time. Progressive Ag is included in the study for the
1996, 1997, and 1998 marketing years, but was not included in 1995 because
it had not yet come to the project’s attention. Utterback Marketing Services
is included in 1997 and 1998, but was not included in 1995 or 1996 because
its marketing programs were not deemed to be clear enough to be followed
by the AgMAS Project. Grain Field Report, Harris Weather/Elliot Advisory,
North American Ag and Prosperous Farmer were in the study in 1995 and/or
1996, but are not included in 1997 or 1998 because they no longer provide
specific recommendations regarding cash sales. Agri-Edge was included
in 1995 and 1996, but the service was discontinued during the 1997 crop
year. Ag Line by Doane hedge program for wheat was introduced for the
1998 crop year. In addition, Agri-Mark, which is included in corn and
soybean evaluations, is not included in the wheat evaluation because their
recommendations are not directed towards a soft red winter wheat producer.
Two forms of sample
selection biases may be potential problems when assembling an advisory
program database. The first form is survival bias, which occurs if only
advisory programs that remain in business at the end of a given
period are included in the sample. Survival bias significantly biases
measures of performance upwards since "survivors" typically
have higher performance than "non-survivors." This form of bias should not be present
in the AgMAS database of advisory programs because all programs ever tracked
are included in the sample. The second and subtler form of bias is hindsight
bias, which occurs if data from prior periods are "back-filled"
at the point in time when an advisory program is added to the database.
Statistically, this has the same effect as survivorship bias because data
from surviving advisory programs are back-filled. This form of bias should
not be present in the AgMAS database because recommendations are not back-filled
when an advisory program is added. Instead, recommendations are collected
only for the marketing period after a decision has been made to
add an advisory program to the database.
The actual daily
process of collecting recommendations for the sample of advisory programs
begins with the purchase of subscriptions to each of the programs. Staff
members of the AgMAS Project read the information provided by each advisory
program on a daily basis. The information is received electronically,
via DTN, websites or e-mail. For the programs that provide two daily
updates, typically in the morning and at noon, information is read in
the morning and afternoon. In this way, the actions of a producer-subscriber
are simulated in “real-time.”
of each advisory program are recorded separately. As noted above, some
advisory services offer two or more distinct marketing programs. This
typically takes the form of one set of advice for marketers who are willing
to use futures and options (although futures and options are not always
used), and a separate set of advice for producers who only wish to make
In this situation, both strategies are recorded and treated as distinct
programs to be evaluated.
When a recommendation
is made regarding the marketing of wheat, the recommendation is recorded.
In recording recommendations, specific attention is paid to which year’s
crop is being sold, (e.g., 1998 crop), the amount of the commodity to
be sold, which futures or options contract is to be used (where applicable),
and any price targets that are mentioned. When price targets are given
and not immediately filled, such as a stop order in the futures market,
the recommendation is noted until the order is either filled or canceled.
are used to check the recorded recommendations for accuracy and completeness.
Whenever possible, recorded recommendations are cross-checked against
later status reports provided by the relevant advisory service. Also,
at the completion of the marketing period, it is confirmed whether cash
sales total 100 percent, all futures positions are offset, and all options
positions are offset or expire.
final set of recommendations attributed to each advisory program represents
the best efforts of the AgMAS Project staff to accurately and fairly interpret
the information made available by each advisory program. In cases where
a recommendation is considered vague or unclear, some judgment is exercised
as to whether or not to include that particular recommendation or how
to implement the recommendation. Given that some recommendations are
subject to interpretation, the possibility is acknowledged that the AgMAS
track record of recommendations for a given program may differ from that
stated by the advisory program, or from that recorded by another subscriber.
Calculating the Returns
to Marketing Advice
the end of the marketing period, all of the (filled) recommendations are
aligned in chronological order. The advice for a given marketing period
is considered to be complete for each advisory program when cumulative
cash sales of the commodity reach 100 percent, all futures positions covering
the crop are offset, all options positions covering the crop are either
offset or expire, and the advisory program discontinues giving advice
for that crop year. The returns to each recommendation are then calculated
in order to arrive at a weighted average net price that would be received
by a producer who precisely follows the marketing advice (as recorded
by the AgMAS Project).
In order to produce
a consistent and comparable set of results across the different advisory
programs, certain explicit assumptions are made. These assumptions are
intended to accurately simulate “real-world” marketing conditions.
Wheat Class and
An issue of first
importance is the appropriate class of wheat and location of production
to use in the simulation. In the US, six classes of wheat are grown and
there are five wheat futures contracts traded on three different exchanges.
Of the six classes, three represent a relatively small level of production:
durum, hard white and soft white wheat. Of the three large classes of
wheat, in 1998 the United States produced 1.2 billion bushels of hard
red winter wheat, 486 million bushels of hard red spring, and 443 million
bushels of soft red winter wheat. Each of these classes has its own distinct
characteristic for the milling and baking industry, and each class is
characterized by the time planted and harvested.
The simulation is
designed to reflect conditions facing a representative soft red winter
wheat producer in southwest Illinois. Whenever possible, data are collected
for the West Southwest Crop Reporting District in Illinois as defined
by the National Agricultural Statistics Service (NASS) of the US Department
of Agriculture (USDA). The thirteen counties (Cass, Pike, Scott, Morgan,
Sangamon, Christian, Calhoun, Greene, Macoupin, Montgomery, Jersey, Madison,
and Bond) that make up this District are highlighted in Figure
1. For ease of reading, this area will be referred to in the remainder
of this report as southwest Illinois, unless it is necessary to reference
the actual crop or price reporting district.
There are two principal
reasons that soft red winter wheat in southwest Illinois is used as the
basis for the simulation. The first reason is that soft red winter wheat
recommendations are the most common class of wheat recommendations made
by advisory programs. All but one of the programs either specifically
make recommendations for this class of wheat or the recommendations most
closely align with this class of wheat. There are three programs included
in the former category; that is, they specifically identify recommendations
by class of wheat. The remaining programs do not specifically identify
the class of wheat, but several pieces of evidence point in the direction
of soft red winter wheat as the target class:
i) Most futures hedging advice refers to the Chicago Board of Trade
(CBOT) wheat contract. In addition, all but one hedge-to-arrive contract
recommendation is based on the CBOT and the vast majority of cash sales
are based on CBOT futures prices. It is important to note that all the
services that provide specific recommendations for individual classes
use the Kansas City Board of Trade (KCBOT) contract for hard red winter,
the Minneapolis Grain Exchange (MGE) contract for hard red spring, and
the CBOT contract for soft red winter.
ii) The programs generally make harvest recommendations for June and
early July. Because the harvest of spring wheat generally occurs in late
summer, while harvest of winter wheat occurs in early summer, the assumption
can be made that the recommendations are for winter wheat.
iii) The programs that give basis advice primarily recommend basis
levels in soft red winter wheat production areas.
second reason that soft red winter wheat in southwest Illinois is used
in the simulation is data availability. An exhaustive search was conducted
for a public series of daily cash and forward contract prices for interior
elevators in major hard red winter, hard red spring, and soft red winter
wheat production areas of the US. Several public sources of cash spot
prices were located for each of the different classes. However, the only
public source of forward contract prices is Illinois Ag Market News, and
they only report bids for soft red winter wheat. This is an important
limiting factor, as many advisory programs make substantial use of pre-harvest
forward contracts. It may be possible to obtain forward contract prices
from private sources in other regions, but this is costly and may result
in forward price data of uncertain accuracy.
In only one instance
did a service fail to provide recommendations that could be applied to
the soft red winter wheat market. Agri-Mark did a majority of hedging
with MGE wheat contracts and only provided harvest recommendations applicable
to hard red spring wheat. As a result, Agri-Mark is not included in this
The final assumption
needed for this aspect of the simulation is the particular production
region in Illinois. The West Southwest Crop Reporting District is chosen
for several reasons. First, a price reporting district is available that
overlaps part of this crop reporting district (see Figure
2). Second, available cash prices for this district come primarily
from non-terminal, interior elevators. Third, this price reporting region
has the most complete set of cash prices for the marketing window. Fourth,
while the West Southwest Crop Reporting District is not the largest wheat
producing region in Illinois, it consistently ranks in the top four production
areas in the state, with 206,000 acres harvested and 10.5 million bushels
produced in 1998.
An important question
is the degree to which performance results based on soft red winter wheat
production in southwest Illinois can be generalized to other classes and
locations of wheat production in the US. To provide some perspective
on this question, yields and prices for two other areas of wheat production
in the US are compared to southwest Illinois. Figure
3 presents the wheat yield history for the West Southwest Illinois
Crop Reporting District (soft red winter), Southwest Kansas Crop Reporting
District (hard red winter), and Northeast South Dakota Crop Reporting
District (hard red spring) over 1972-1998. Yields have trended upward
in each area. Hence, a valid correlation across the production areas
can only be made after removing the upward trend from the yields for each
area. Figure 4 presents
the relationship between deviations from trend across the areas and the
corresponding correlation coefficients. A correlation coefficient can
be between positive one and negative one. The correlation of the deviations
from trend shows a weak positive relationship between the yield deviations
for southwest Illinois and the other two regions. There is only a slight
tendency for southwest Illinois wheat yields to be above trend at the
same time that Kansas or South Dakota yields are above trend, and vice
of the divergent yield pattern across the three wheat production areas
is found in Table 1, which
focuses on yield and deviation from trend over the past four years, the
same period as the analysis of advisory service performance in pricing
wheat. There is not a single year over the 1995 to 1998 period in which
the direction of deviation from trend is the same for all three areas.
Yields in 1995 and 1996 are below trend for Illinois and Kansas, but above
trend in South Dakota. Yield in 1997 is above trend for Illinois, but
near trend in Kansas and below trend in South Dakota. Finally, yield in
1998 is below trend in Illinois, above trend in Kansas and near trend
in South Dakota.
The history of daily
cash prices for wheat in Illinois, Kansas and South Dakota is presented
in Figures 5 and 6 for the
period June 1995 through May 1999. Soft red winter wheat prices are shown
for the West Southwest Illinois Price Reporting District, hard red winter
wheat prices are shown for the Western Kansas Price Reporting District
and hard red spring wheat prices are shown for the East River South Dakota
Price Reporting District. These price districts most closely match the
crop districts used above to compare yields. Comparison of the price
histories for the three areas suggests wheat prices track fairly closely.
However, there are periods when the relationship changes. An example
is 1997, when Kansas hard red winter wheat prices moved from a premium
relative to South Dakota hard red spring wheat prices to a discount.
A more formal analysis
of the relationship of cash prices between the three areas is reported
in Figure 7. Price changes are analyzed because the time series properties
of commodity prices strongly suggest that unbiased estimates of price
correlations should be based on price changes rather than price levels. The correlations are highly positive
between Illinois and the other two areas. Not surprisingly, a high correlation
is observed between Illinois and Kansas, as these two areas produce winter
wheat. It is interesting to note that the correlation estimate of 0.83
is quite close to similar estimates reported in studies of optimal wheat
cross-hedging. The correlation is also high between Illinois
and South Dakota, even though Illinois produces winter wheat and South
Dakota produces spring wheat. Finally, while these correlations are based
on cash prices, it is expected that similar correlations exist across
futures prices for the different wheat classes, due to inter-market spread
trading and arbitrage.
The previous results
present a mixed picture regarding the degree to which performance results
based on soft red winter wheat production in southwest Illinois can be
generalized to other classes and locations of wheat production in the
US. On one hand, there appears to be little relationship in wheat yields
across classes and locations. On the other hand, there is a highly positive
relationship between wheat prices across classes and locations. It is
an empirical question whether the lack of a relationship between yields
or the positive relationship between prices has the dominant impact on
performance evaluations. One plausible outcome is that the low correlation
in yields is more than offset by the high correlation in prices, and hence,
it is reasonable to generalize performance evaluations for soft red winter
wheat production in southwest Illinois to other wheat classes and locations.
An equally plausible outcome is that the low correlation in yields more
than offsets the high correlation in prices, and hence, it is unreasonable
to generalize performance evaluations for soft red winter wheat production
in southwest Illinois to other wheat classes and locations. Until empirical
evidence is available on this question, caution is suggested before attempting
to generalize the performance results to other wheat classes and locations.
In general, a two-year
marketing window, spanning June 1st of the year prior to harvest
through May 31st of the year following harvest, is used in
the analysis. The beginning date is selected because it reflects a time
at which new crop sales begin. The ending date is selected to be consistent
with the ending date for wheat marketing years as defined by the USDA.
There are some exceptions
to the marketing window definition. Three advisory programs have relatively
small amounts (15 percent or less) of cash wheat unsold at the end of
the 1995 marketing period (May 31, 1996). The last cash sale by an advisory
program for the 1995 crop is made on October 18, 1996. Six advisory programs
do not complete cash sales by the end of the 1996 marketing period (May
31, 1997). These six programs have between 5 and 60 percent of the 1996
crop unsold. The last cash sale for these positions is made on August
12, 1997. One program does not make any cash sales by the end of the
1996 marketing year, but did complete cash sales by June 10, 1997. Five
programs have between 10 and 100 percent of the 1997 wheat crop unsold
at the end of the 1997 marketing period (May 31, 1998). The last cash
sale for four of these programs is completed by August 12, 1999. The
other program continues to hold all of the 1997 wheat crop. Four programs
have between 10 and 100 percent of the 1998 wheat crop unsold at the end
of the 1998 marketing period (May 31, 1999). One program, with the smallest
amount of unsold cash wheat, ten percent, makes its last cash sale on
June 8, 1999. Another program, with 75 percent unsold at the end of the
1998 marketing period, makes its last cash sale on April 3, 2000. The
remaining two programs continue to hold all of the 1998 wheat crop.
The discussion in
the previous paragraph indicates a unique problem not confronted in other
AgMAS pricing evaluations. 
That is, two programs did not complete marketing of wheat by the time
of the analysis for this report, June 2000. The specifics of these positions are worth noting.
As of May 31, 2000, the Allendale (futures only) program had not recommended
any cash sales for either the 1997 or 1998 wheat crops. However, both
crops are fully hedged using wheat futures. As of May 31, 2000, Ag Profit
by Hjort Associates had not sold any of the 1998 wheat crop. In order
to complete the analysis for these two programs, the futures positions
and all remaining cash quantities are marked-to-the-market as of May 31,
2000. Future AgMAS wheat pricing reports will update and revise results
when these programs make final pricing decisions.
The cash price assigned
to each cash sale recommendation is the West Southwest Illinois Price
Reporting District closing, or overnight, bid. The West Southwest Illinois
Price Reporting District is highlighted in Figure 2. Similarly, the forward
contract price assigned to all pre-harvest forward sales is the forward
bid for the West Southwest Price Reporting District. The cash and forward
contract data are collected and reported by the Illinois Department of
Ag Market News.
Cash and forward contract prices in this area best reflect
prices for the assumed geographic location of the representative southwest
Illinois producer (West Southwest Illinois Crop Reporting District).
There are two periods
when cash wheat prices are not publicly reported by the Illinois Department
of Ag Market News: May 1, 1996 – June 12, 1996 and October 1, 1998 –
May 28, 1999. While the Illinois Department of Ag Market News does not
report cash prices for these two periods, it continues to survey elevators
and collect price data. This data is obtained directly from the Illinois
Department of Ag Market News and the cash wheat price is computed by taking
the midpoint of the high and the low prices reported by elevators for
the West Southwest Price Reporting District. In addition, there are six
business days when cash prices are not reported publicly and the Illinois
Department of Ag Market News does not collect price data (April 24-30,
1996; December 17, 1998). For these six days, cash prices are estimated.
The first step in the estimation is to compute the average spatial basis
between the St. Louis terminal cash wheat price and West Southwest Price
Reporting District wheat price for the five days before and after the
missing date. Next, the average spatial basis is added to the St. Louis
cash price on the missing date to obtain a representative cash price for
the West Southwest Price Reporting District.
Since the marketing
window for the wheat crop begins in June of the year prior to harvest,
and the Illinois Department of Ag Market News does not typically begin
reporting actual cash forward bids until January before harvest, pre-harvest
prices need to be estimated for the first seven months of the marketing
window. Between June 1st and January prior to harvest, a two-step
estimation procedure is adopted. First, the forward basis for the period
in question is estimated using the average forward basis for the first
five days that actual forward contract bids are reported by the Illinois
Department of Ag Market News. Second,
the estimated forward basis is subtracted from the settlement price of
the Chicago Board of Trade (CBOT) July wheat futures contract for the
respective years during the period when forward contract data are missing.
This estimation procedure is expected to be a reasonably accurate reflection
of actual forward cash prices for the early period of the marketing window,
as the actual price of the harvest futures contract is used and only the
forward basis is estimated.
The fill prices for
futures and options transactions generally are the prices reported by
the services. In cases where a service did not report a specific fill
price, the settlement price for the day is used. This methodology does
not account for liquidity costs in executing futures and options transactions.
Since most of the
advisory program recommendations are given in terms of the proportion
of total production (e.g., “sell 10 percent of 1998 crop today”), some
assumption must be made about the amount of production to be marketed.
For the purposes of this study, if the per-acre yield is assumed to be
50 bushels, then a recommendation to sell 10 percent of the wheat crop
translates into selling 5 bushels. When all of the advice for the marketing
period has been carried out, the final per-bushel selling price is the
average price for each transaction weighted by the amount marketed in
The above procedure
implicitly assumes that the “lumpiness” of futures and/or options contracts
is not an issue. Lumpiness is caused by the fact that futures contracts
are for specific amounts, such as 5,000 bushels per CBOT wheat futures
contract. For large-scale producers, it is unlikely that this assumption
adversely affects the accuracy of the results. This may not be the case
for small- to intermediate-scale producers who are less able to sell in
Yields and Harvest
When making hedging
or forward contracting decisions prior to harvest, the actual yield is
unknown. Hence, an assumption regarding the amount of expected production
per acre is necessary to accurately reflect the returns to marketing advice.
As shown earlier in Table 1, wheat yields in southwest Illinois vary greatly
over 1995-1998. When yield is near or above trend, there is not normally
a problem in meeting forward pricing obligations. Hence, in a “normal”
crop year, expected yield is assumed to equal trend yield for the entire
pre-harvest period. The adjustment from expected to actual yield in this
case is assumed to occur on the first day of wheat harvest. The expected
yield for the West Southwest Illinois Crop Reporting District is computed
from a linear regression trend model of actual yields from 1972 through
the year previous to harvest. For example, the trend yield forecast for
1998 is based on a regression using 1972 to 1997 yield data. Previous
research suggests a regression trend model produces relatively accurate
When actual yield
is substantially below trend, and forward pricing obligations are based
on trend yields, a producer may have difficulty meeting such obligations.
This raises the issue of updating yield expectations in “short” crop years
to minimize the chance of defaulting on forward pricing obligations.
A relatively simple
procedure is used to update yield expectations in short crop years. First,
trend yield is used as the expected yield until the May USDA Crop Production
Report is released, typically around May 10th. Second,
if the USDA wheat yield estimate for Illinois is 20 percent (or more)
lower than trend yield, a “reasonable” producer is assumed to change yield
expectations to the lower USDA estimate. Third, as with normal crop years,
the adjustment to actual yield is assumed to occur on the first day of
The 20 percent threshold
is intentionally relatively large for at least three reasons. First,
it is desirable to make adjustments to the trend yield expectation on
a limited number of occasions. Given the large variability in annual
yields, a small threshold could result in frequent adjustments. Second,
it is not uncommon for early yield estimates to deviate significantly
from the final estimate. A small threshold could result in unnecessary
adjustments prior to harvest. Third, yield short-falls of less than 20
percent are unlikely to create delivery problems for a producer.
In southwest Illinois,
1995, 1997, and 1998 are classified as “normal” crop years. The trend
yield for 1995 is calculated to be 56 bushels per acre (bpa). A short
crop adjustment is not triggered in 1995 since the May USDA estimate did
not indicate a deviation below trend greater than 20 percent. Therefore,
recommendations regarding the marketing quantity made prior to harvest
are based on yields of 56 bpa. For example, a recommendation to forward
contract twenty percent of expected 1995 production translates into a
recommendation to contract 11.2 bpa (20 percent of 56). The actual reported
wheat yield in southwest Illinois in 1995 is 45 bpa. The trend yield
in 1997 is 52 bpa and actual production is 65 bpa. The trend yield in
1998 is 54 bpa and actual production is 51 bpa. In neither of these latter
two years does the May USDA estimate trigger a short-crop yield expectation
In southwest Illinois,
1996 is classified as a “short” crop year. The trend yield for 1996 is
54 bpa. Using the procedure described above, a short-crop adjustment
is triggered because USDA’s estimate of yield in May 1996 is 41 bpa, more
than 20 percent below trend. Therefore, forward sales recommended after
the USDA estimate is released are based on an expected yield of 41 bpa.
The actual yield in 1996 is 38 bpa, 30 percent less then trend.
Since harvest occurs
at different dates each year, estimates of harvest progress, as reported
by NASS in Illinois, are used to determine the actual date of harvest.
Harvest progress estimates typically are not made soon enough to identify
precisely the beginning of harvest, so an estimate is made based upon
available data. Specifically, the date on which 50 percent of the crop
is harvested is defined as the "mid-point" of harvest. The
entire harvest period then is defined as a three-week window, beginning
one and one-half weeks before the harvest mid-point, and ending one and
one-half weeks after the harvest mid-point. In most years, a three-week
window includes at least 80 percent of the harvest.
For 1995, the harvest
period for wheat is defined as June 23, 1995 through July 14, 1995. For
1996, the harvest period is June 25, 1996 through July 16, 1996. For
1997, the harvest period is June 27, 1997 to July 18, 1997. Finally,
the 1998 harvest period is June 18, 1998 to July 8, 1998. As stated earlier,
wheat recommendations made after the beginning harvest dates are applied
on the basis of actual yields.
For the purpose of
this study, the actual harvest yield must exactly equal total cash sales
of the crop at the end of the marketing window. Hence, an adjustment
in yield assumptions from expected to actual levels must be applied to
cash transactions at some point in time. In normal crop years, an adjustment
is made to the amount of the first cash sale after the beginning of the
harvest period. For example, if a program advises forward contracting
50 percent of the 1998 wheat crop prior to harvest, this translates into
sales of 27 bpa (50 percent of 54). However, when the actual yield is
applied to the analysis, sales-to-date of 27 bpa imply that 52.94 percent
([27/51]*100) of the actual crop has been contracted. In order to compensate,
the amount of the next cash sale is adjusted to align the amount sold.
In this example, if the next cash sale recommendation is for a 10 percent
increment of the 1998 crop, making the total recommended sales 60 percent
of the crop, the recommendation is adjusted to 7.06 percent (60 – 52.94)
of the actual yield (3.6 bushels), so that the total crop sold to date
is 60 percent of 51.0 bushels per acre (27 + 3.6 = 0.6*51 = 30.6 bushels).
After this initial adjustment, subsequent recommendations are taken as
percentages of the 51 bpa actual yield, so that sales of 100 percent of
the crop equal sales of 51 bpa.
In short crop years
there is an additional adjustment made in May. For example, if a program
advised forward contracting 50 percent of the 1996 crop prior to May 1996,
this would be 27 bpa (50 percent of 54). If on May 30, 1996, a program
recommends forward contracting another 25 percent of the crop and an expected
yield of 54 bpa is used, the producer would forward contract another 13.5
bpa (25 percent of 54), for a total forward contract amount of 40.5 bpa
(27 + 13.5 = 40.5 = 0.75*54). However, the actual yield for 1996 is only
38 bpa! As noted above, it is assumed that a “reasonable” producer uses
the May USDA Crop Report estimate of 41 bpa for forward contracting purposes.
Now assume that on May 30, 1996, that same recommendation to forward contract
25 percent of expected production is made. This brings the amount forward
contracted to a total of 75 percent of the crop. This sale is adjusted,
so that the actual bushels contracted is 3.75 bpa (27 + 3.75 = 0.75*41
= 30.75 bushels). On the first cash sale after harvest, there is
an additional adjustment. In this example, if the next cash sale recommendation
is after the harvest for a 10 percent increment of the 1996 crop, making
the total recommended sales 85 percent of the crop, the recommendation
is adjusted to 4 percent of the actual yield (1.55 bushels), so that the
total crop sold to date is 85 percent of 38 bushels per acre (27 + 3.75
+ 1.55 = 0.85*38 = 32.3 bushels). After this initial adjustment, subsequent
recommendations are taken as percentages of the 38 bpa actual yield, so
that sales of 100 percent of the crop equal sales of 38 bpa.
While the amount
of cash sales is adjusted to reflect the change in yield information,
a similar adjustment is not made for futures or options positions that
are already in place. For example, assume that a short futures hedge
is placed in the July 1998 contract for 25 percent of the 1998 crop prior
to harvest. Since the amount hedged is based on the trend yield assumption
of 54 bpa, the futures position is 13.5 bpa (25 percent of 54). After
the yield assumption is changed, this amount represents a short hedge
of 26.47 percent ([13.5/51]*100). The amount of the futures position
is not adjusted to move the position to 25 percent of the new yield figure.
However, any futures (or options) positions recommended after the beginning
of harvest are implemented as a percentage of the actual yield.
Brokerage costs are
incurred when producers open or close positions in futures and options
markets. For the purposes of this study, it is assumed that brokerage
costs are $50 per contract for round-turn futures transactions, and $30
per contract to enter or exit an options position. Further, it is assumed
that CBOT wheat futures or options contracts are used, and the contract
size for each commodity is 5,000 bushels. Therefore, per-bushel brokerage
costs are 1 cent per bushel for a round-turn futures transaction and 0.6
cents per bushel for each options transaction.
LDP and Marketing
Assistance Loan Payments
While the 1996 “Freedom-to-Farm”
Act did away with government set-aside and target price programs, price
protection for producers in program crops such as wheat are not eliminated
entirely. Minimum prices are established through a “loan” program. Specifically,
if market prices are below the Commodity Credit Corporation (CCC) loan
rate for wheat, producers can receive payments from the US government
that make up the difference between the loan rate and the lower market
price. There is considerable flexibility in the way
the loan program can be implemented by producers. This flexibility presents
the opportunity for advisory programs to make specific recommendations
for the implementation of the loan program. Additionally, the price of
wheat was below the loan rate during significant periods of time in the
1998 marketing period, so that use of the loan program was an important
part of marketing strategies for this period. As a result, net advisory
program prices may be substantially impacted by the way the provisions
of the loan program are implemented. It should be noted that loan program
decisions are only considered for 1998 marketing year and are not considered
for the 1995 through 1997 crops, unless specifically recommended, because
the market price exceeded the loan rate.
Most of the advisory
programs tracked by the AgMAS Project for the 1998 crop make specific
recommendations regarding the timing and method of implementing the loan
program for the entire wheat crop. These recommendations
are implemented as given wherever feasible. Several decision rules have
to be developed even in this case, in particular, for pre-harvest forward
contracts. For a few programs, loan recommendations are incomplete or
not made at all. For these cases, it is necessary to develop a more complete
set of decision rules for implementing the loan program in the marketing
of wheat. All loan-related decision rules are based on the assumption
of a “prudent” or “rational” producer, within the context of the intent
of the loan program. More specifically, it is assumed that a producer
will take advantage of the price protection offered by the loan program,
even in the absence of specific advice from an advisory program.
the decision rules, it is useful to provide a brief overview of the loan
program mechanics. Then, the rules developed to implement the loan program
in the absence of specific recommendations can be described more effectively.
There are two mechanisms
for implementing the price protection benefits of the loan program. The
first mechanism is the loan deficiency payment (LDP) program. LDPs are
computed as the difference between the loan rate for a given county and
the posted county price (PCP) for a particular day. PCPs are computed
by the USDA and change each day in order to reflect the “average” market
price that exists in the county. For example, if the county loan rate
for wheat is $2.50 per bushel and the PCP for a given day is $2.00 per
bushel, then the next day LDP is $0.50 per bushel. If the PCP increases
the next day to $2.10 per bushel, the LDP after the next day will decrease
to $0.40 per bushel. Conversely, if the PCP decreases the next day to
$1.90 per bushel, after the next day the LDP will increase to $0.60 per
LDPs are made available
to producers over the period beginning with wheat harvest and ending March
31st of the calendar year following harvest. Producers have
flexibility with regard to taking the LDP. They may simply elect to take
the payment when the crop is sold in a spot market transaction (before
the end of March in the particular marketing year). Or, producers, after
harvest, can choose to take the LDP before the crop is delivered and sold.
Note that LDPs for the 1998 crop cannot be taken after a crop has been
delivered and title has changed hands.
second mechanism is the nonrecourse marketing assistance loan program.
A loan cannot be taken on any portion of the crop for which an LDP has
been received. Under this program, producers may store the crop (on the
farm or commercially), maintain beneficial interest, and receive a loan
from the CCC using the stored crop as collateral. The loan rate is the
established rate in the county where the crop is stored and the interest
rate is established at the time of loan entry. Wheat can be placed under
loan anytime after the crop is stored through March 31st of
the following calendar year. The loan matures on the last day of the
ninth month following the month in which the loan was made.
Producers may settle
outstanding loans in two ways: i) repaying the loan during the 9-month
loan period, or ii) forfeiting the crop to the CCC at maturity of the
loan. Under the first alternative, the loan repayment rate is the lower
of the county loan rate plus accrued interest or the marketing loan repayment
rate, which is the PCP. If the PCP is below the county loan rate, the
economic incentive is to repay the loan at the posted county price. The
difference between the loan rate and the repayment rate is a marketing
loan gain (MLG). If the PCP is higher than the loan rate, but lower than
the loan rate plus accrued interest, the incentive is also to repay the
loan at the PCP. Interest is charged on the difference between the PCP
and the loan rate. If the PCP is higher than the loan rate plus accrued
interest, the incentive is to repay the loan at the loan rate plus interest.
Under the second
alternative, the producer stores the crop to loan maturity and then transfers
title to the CCC. The producer retains the proceeds from the initial loan.
This was generally not an attractive alternative in the 1998 marketing
year since the PCP was often below the cash price of wheat. Repaying
the loan at the PCP and selling the crop at the higher cash price was
economically superior to forfeiture.
The nonrecourse loan
program establishes the county loan rate as a minimum price for the producer,
as does the LDP program. For the 1998 crop, the sum of LDPs plus marketing
loan gains was subject to a payment limitation of $75,000 per person.
Forfeiture on the loans provided the mechanism for receiving a minimum
of the loan rate on bushels in excess of the payment limitation.
The average loan
rates for the 1998 wheat across the thirteen counties in the West Southwest
Illinois Crop Reporting District (Bond, Calhoun, Cass, Christian, Greene,
Jersey, Macoupin, Madison, Montgomery, Morgan, Pike, Sangamon, and Scott)
is $2.57 per bushel. Market prices fell below that rate for extended
periods of time during the 1998 marketing year. This is reflected in
Figure 8, which shows the average wheat LDP or MLG rates for the West
Southwest Illinois Crop Reporting District during the 1998 marketing year.,
 LDPs or MLGs vary greatly during harvest, from
zero cents to 20 cents per bushel, and then rise to 60 cents or greater
during late summer, decline in the fall and rise to maintain a level at
or above 25 cents for the remainder of the marketing year.
Decision Rules for
Programs with a Complete Set of Loan Recommendations
an advisory program makes a complete set of loan recommendations, the
specific advice is implemented wherever feasible. However, specific decision
rules are still needed regarding pre-harvest forward contracts because
it is possible for an advisory program to recommend taking the LDP on
those sales before it is actually harvested and available for delivery
in southwest Illinois. To begin, it is assumed that amounts sold for
harvest delivery with pre-harvest forward contracts are delivered first
during harvest. Since LDPs must be taken when title to the grain changes
hands, LDPs are assigned as these “forward contract” quantities are harvested
and delivered. This necessitates assumptions regarding the timing and
speed of harvest. Earlier it was noted that a three-week harvest window
is used to define harvest. This window is centered on the day nearest
to the mid-point of harvest progress as reported by NASS. Various assumptions
could be implemented regarding harvest progress during this window. Lacking
more precise data, a reasonable assumption is that harvest progress for
an individual, representative farm is a linear function of time.
2 summarizes the information used to assign LDPs to pre-harvest forward
contracts. The second column shows the amount harvested assuming a linear
model. The third column shows the LDP available on each date of the harvest
window and the third column presents the average LDP through each harvest
date. An example will help illustrate use of the table. Assume that
an advisory program recommends, at some point before harvest, that a producer
forward contract 50 percent of expected wheat production. This translates
into 27 bpa when the percentage is applied to expected production (0.50*54
= 27). Next, convert the bpa to a percentage of actual production, which
is 52.94 percent ([27/51]*100) = 52.94). To determine the LDP payment
on the 52.94 percent of actual production forward contracted, simply read
down Table 2 to June 29, which is the date when 53.3 percent of harvest
is assumed to be complete. The average LDP up to that date (June 18,
1998 to June 29, 1998) is $0.02 per bushel. This is the LDP amount assigned
to the forward contract bushels.
that LDPs for any sales (spot, forward contracts, futures or options)
recommended during harvest are taken only after all forward contract obligations
are fulfilled. In addition, crops placed under loan by an advisory program
do not accumulate interest opportunity costs because proceeds from the
loan can be used to offset interest costs that otherwise would accumulate.
Decision Rules for
Programs with a Partial Set of Loan Recommendations or No Loan Recommendations
an advisory program makes a partial set of loan recommendations, the available
advice is implemented wherever feasible. In the absence of specific recommendations,
it is assumed that crops priced before March 31, 1999 are not placed under
loan. Those crops receive program benefits through LDPs. After March
31, 1999, eligible crops (unpriced crops for which program benefits have
not yet been collected) are assumed to be under loan until priced.
the absence of specific recommendations, rules for assigning LDPs and
MLGs are developed under the assumption that loan benefits are established
when the crop is priced or as soon after pricing that is allowed under
the rules of the program. This principle is consistent with the intent
of the loan program to fix a minimum price when pricing decisions are
made. Two rules are most important in the implementation of this principle.
First, LDPs on pre-harvest sales (forward contracts, futures or options)
are established as the crop is harvested. Second, if the LDP or MLG is
zero on the pricing date, or the first date of eligibility to receive
a loan benefit, those values are assigned on the first date when a positive
value is observed, assuming a beneficial interest in that portion of the
crop has been maintained. Specific rules for particular marketing tools
and situations follow:
forward contracts. The same decision rules are applied as discussed
in the previous section. Specifically, it is assumed that amounts sold
for harvest delivery with pre-harvest forward contracts are delivered
first during harvest. LDPs, if positive, are assigned as these “forward
contract” quantities are harvested and delivered. This necessitates assumptions
regarding the timing and speed of harvest. A linear model of harvest
progress is assumed in the three-week harvest window. The specific information
used to assign LDPs to pre-harvest forward contracts is again found in
Table 2. As a final point,
note that LDPs for any other sales (spot, futures or options) recommended
during harvest are taken only after all pre-harvest forward pricing obligations
short futures. Pre-harvest pricing using futures contracts is treated
in the same manner as pre-harvest forward contracts. LDPs are assigned
on open futures positions as the crop is harvested, or as soon as a positive
LDP is available, if the futures position is still in place and cash sales
have not yet been made. These are assigned after forward contracts have
been satisfied. If the underlying crop is sold before there is a positive
LDP, then that portion of the crop receives a zero LDP. If the futures
position is offset before a positive LDP is available and the crop has
not yet been sold in the cash market, that portion of the crop is eligible
for loan benefits on the next pricing recommendation.
put option purchases.
Long put options positions, which establish a minimum futures price, are
treated in the same manner as pre-harvest short futures.
forward contracts. The main issue with respect to post-harvest forward
contracts is when to assign the LDPs or MLGs. Those can be established
on the date the contract is initiated, on the delivery date of the contract,
or anytime in between. Following the general principle outlined earlier,
LDPs and MLGs for post-harvest contracts are assigned on the date the
contract is initiated or the first day with positive benefits prior to
delivery on the contract.
short futures. As with post-harvest forward contracts, the main issue
with post-harvest short futures positions is when to assign loan benefits.
These are assigned when the short futures position is initiated or as
soon as a positive benefit is available if the futures position is still
in place and cash sales have not been made. If the underlying crop is
sold before a positive LDP is available, that portion of the crop receives
a zero LDP. If the short futures position is offset before a positive
LDP is available and the cash crop has not yet been sold, that portion
of the crop is eligible for loan benefits on the next pricing recommendation.
long put positions. Long put options positions established after
the crop is harvested are treated in the same manner as post-harvest short
sales before March 31, 1999. If a spot cash sale of wheat is recommended
before March 31, 1999, it is assumed that the LDP, if positive, is established
that same day.
program after March 31, 1999. Since LDPs are not available after
March 31, 1999, it is assumed that any wheat in storage and not priced
as of this date, for which loan benefits have not been established, are
entered in the loan program on that date. This is a reasonable assumption
since spot prices were below the loan rate for wheat in southwest Illinois
on March 31 and a prudent producer would take advantage of the price protection
offered by the loan program. When the crops are subsequently priced (cash
sale, forward contract, short futures, or long put options), the marketing
loan gain, if positive, is assigned on that day. Forfeiture is not an
issue for these bushels because all cash sales were made before the end
of nine-month loan period (December 31, 1999). Note also that the $75,000
payment limitation is not considered in the analysis, as production is
based on one acre of wheat.
An important element
in assessing returns to an advisory program is the economic cost associated
with storing grain instead of selling grain immediately at harvest. The
cost of storing grain after harvest (carrying costs) consists of two components:
physical storage charges and the opportunity cost incurred by foregoing
sales when the crop is harvested. Physical storage charges can apply
to off-farm (commercial) storage, on-farm storage, or some combination
of the two. Opportunity cost is the same regardless of the type of physical
For the purposes
of this study, it is assumed that all storage occurs off-farm at commercial
sites. This is assumed
for several reasons. First, commercial storage costs reflect the full
economic costs of physical storage, whereas on-farm storage cost estimates
may not, due to differing accounting methods and/or time horizons. Second,
commercial storage costs are relatively consistent across producers in
a given area, whereas on-farm storage costs likely vary substantially
among producers. Third, commercial storage cost data are readily available,
whereas this is not the case for on-farm storage.
Storage charges are
assigned beginning with the first day after the end of a harvest window.
Physical storage charges have a fixed component (in-charge) of 4 cents
per bushel that is assigned the day storage begins. The variable component
is 2.5 cents per bushel per month, with this charge pro-rated to the day
when the cash sale is made. The storage costs represent the typical storage
charges for the 1995, 1996, 1997, and 1998 wheat crops quoted in a telephone
survey of southwest Illinois elevators.
The interest rate
is assumed to be 9.5 percent for 1995, 8.6 percent for 1996, 9.4 percent
for 1997, 9.0 percent for 1998, and 8.9 percent for 1999 and is applied
to the average harvest-time price for each crop. This interest rate is
the average rate for all commercial agricultural loans for the third quarter
of each year as reported in the Agricultural Finance Databook published
by the Board of Governors of the Federal Reserve Board. The third quarter
rate represents the interest opportunity costs at the end of harvest for
a wheat producer. The interest charge for storing grain is the interest
rate compounded daily from the end of harvest to the date of sale.
calculation of carrying charges may be impacted by an advisory program’s
loan recommendations and/or the decision rules discussed in the previous
section. Specifically, during the period wheat is placed under loan,
interest costs are not accumulated, as the proceeds from the loan can
be used to offset interest opportunity costs that otherwise would accumulate.
This most commonly occurs after March 31, 1999, when it is assumed that
all unpriced grain for which loan benefits have not been established is
placed under loan until priced. If a crop is priced while under loan
(the loan is assumed to be repaid on the same date), but stored beyond
the time of pricing, interest opportunity costs are accumulated from the
day of pricing until the time storage ceases.
it could be argued that interest opportunity costs should be charged based
on the LDP available at harvest but not taken by an advisory program.
This adjustment is not made for two reasons. First, it would not substantially
impact the results due to the small interest opportunity costs involved.
Second, anecdotal evidence suggests that there may be considerable delay
in LDP payments actually reaching producers, with lags of several months
apparently not uncommon.
In addition to comparing
the net price received across advisory programs, it is useful to compare
the results to simple market benchmark prices. These prices are intended
to provide information about the actual prices that are available for
a particular crop, and provide an indication of how producers might fare
using some basic marketing strategies that do not require professional
The development of
an appropriate market benchmark for advisory service performance analysis
is considered in a recent AgMAS research report.
 In this report,
it is argued that a useful benchmark should: i) be simple to understand
and to calculate; ii) represent the returns to a marketing strategy that
could be implemented by producers; iii) be directly comparable
to the net advisory price received from following the recommendations
of a market advisory program; iv) not be a function of the actual recommendations
of the advisory programs or of the actual marketing behavior of producers,
but rather should be external to their marketing activities; and
v) be stable, so that it represents the range of prices made available
by the market throughout the marketing period instead of representing
the price during a small segment of the marketing period.
Three potential specifications
are considered in the aforementioned research on market benchmarks for
corn and soybeans: the average price received by farmers, the harvest
cash price, and the average cash price over a two-year time span that
extends from one year prior to harvest through one year after harvest.
The average price received by farmers is reported by the USDA and is widely
cited as a measure of the economic condition of the farm sector. It is
not directly comparable to the net advisory price, however, because it
includes quality discounts and premiums. The average price received also
is a function of farmers’ actual marketing behavior. The harvest cash
price is straightforward and easy to calculate because production risk
and storage costs are not included. However, in a given year, the harvest
cash price may not represent the average price that is available to farmers
for that crop.
The average cash
price benchmark meets all of the selection criteria listed above, except
it may not be easily implemented by producers since it involves marketing
a small portion of each crop every day of the two-year marketing window.
It is shown for corn and soybeans, though, that the price realized via
a more manageable strategy of routinely selling twelve times during the
marketing window very closely approximates the average cash price. Therefore,
it is determined that the average cash price meets all five selection
criteria and is the most appropriate market benchmark to be used in evaluating
the pricing performance of market advisory programs. This benchmark is
employed in the 1997 and 1998 AgMAS corn and soybean pricing evaluations.
Consistent with AgMAS
corn and soybean evaluations, the market benchmark price for wheat used
in this study is the 24-month average cash price stated on a harvest equivalent
basis. Using 1998 as an example, the benchmark is based on the average
price over the 1998 marketing period, which began on June 1, 1997 and
ended on May 31, 1999. Cash forward prices for West Southwest Illinois
Price Reporting District are used during the pre-harvest period, while
daily spot prices for the West Southwest Illinois Price Reporting District
are used for the post-harvest period. The same forward and spot price
series applied to advisory program recommendations are used to construct
the benchmark. Details on the forward and cash price series can be found
in the earlier “Prices” section of this report.
are made to the daily cash prices to make the average cash price benchmark
consistent with the calculated net advisory prices for each marketing
program. The first is to take a weighted average price, to account for
changing yield expectations, instead of taking the simple average of the
daily prices. This adjustment is consistent with the procedure described
previously in the "Expected Yield" section. The daily weighting
factors for pre-harvest prices are based on the calculated trend yield,
while the weighting of the post-harvest prices is based on the actual
reported yield for southwest Illinois. The second adjustment is to compute
post-harvest cash prices on a harvest equivalent basis, which is done
by subtracting carrying charges (storage and interest) from post-harvest
spot cash prices. The daily carrying charges are calculated in the same
manner as those for net advisory prices.
The third adjustment
deals with the low yield in 1996. The benchmark expected yield is reduced
due to the May USDA crop estimate triggering a short-crop adjustment of
yield expectations. At the time of the USDA report release, the benchmark
yield is reduced from 54 bpa to the USDA estimate of 41 bpa, then reduced
again on the first day of harvest to the actual yield of 38 bpa.
The final adjustment
to the average cash price benchmark is needed only for 1998 computations.
In the context of evaluating advisory program recommendations, it was
argued earlier that a “prudent” or “rational” producer would take advantage
of the price protection offered by the loan program, even in the absence
of specific advice from an advisory program. This same logic suggests
that a “prudent” or “rational” producer will take advantage of the price
protection offered by the loan program when following the benchmark average
price strategy. Based on this argument, the average cash price benchmark
is adjusted by the addition of LDPs and MLGs. Bushels marketed in the
1998 pre-harvest period according to the benchmark strategy (approximately
53 percent) are treated as forward contracts with the LDPs assigned at
harvest. Bushels marketed in 1998 each day in the post-harvest period
(approximately 47 percent) are awarded the LDP or MLG in existence for
that particular day. Finally, just as in the case with comparable advisory
program recommendations, interest opportunity costs are not charged to
the benchmark after March 31, 1999 to reflect the assumption that stored
grain is placed under loan.
performance results may be sensitive to the choice of market benchmark,
Table 3 presents a comparison of alternative wheat market benchmarks for
1995 through 1998. The first benchmark is the 24-month average cash price
described above. The second benchmark averages prices for the 20-month
period starting in October of the year previous to harvest and ending
in May of the year after harvest. The only difference between this alternative
and the 24-month benchmark is the exclusion of the pre-harvest period
previous to October. Hence, the 20-month benchmark places more weight
on post-harvest prices than pre-harvest prices. The third benchmark averages
prices only for a 16-month marketing window, which excludes prices previous
to February. The fourth benchmark is the harvest cash price, computed
as the average daily cash price for the three-week harvest window.
For a given year,
price varies considerably across market benchmarks. For example, the
range from the highest to lowest benchmark in 1996 is sixty-six cents
per bushel. However, there is no clear pattern in the variation of the
benchmarks relative to one another. As a result, average benchmark prices
are similar for the entire four-year period. The four-year averages for
the three average cash price benchmarks differ by at most one cent. This
is not surprising given the nature of the average cash price benchmarks.
In informationally efficient markets, averages of different cash price
benchmarks should be roughly similar when stated on a harvest equivalent
basis. The 24-month benchmark demonstrates less year-to-year variation
than the other two benchmarks, as reflected in the smaller standard deviation.
The four-year average harvest cash price is thirteen to fourteen cents
per bushel higher than the other benchmarks, likely due to the unusually
high wheat prices during harvest 1996. This demonstrates the potential
instability of the harvest cash price benchmark relative to average cash
price benchmarks, particularly in small samples. Overall, these results
indicate pricing performance evaluations are not likely to be overly sensitive
to the choice of the 24-month average cash price benchmark.
As with previous
studies for corn and soybeans, the major concern about using the 24-month
benchmark is whether or not producers could actually achieve the benchmark.
The outcomes for three mechanical marketing strategies were calculated
and are presented in Table 3.
The strategy of routinely selling an equal portion of the crop on the
fifteenth of each month for the two-year marketing window reproduced the
24-month benchmark almost identically in each year of the study.
Results for the Advisory Programs
results for the 1995, 1996, 1997 and 1998 wheat crops are presented in
Tables 4 through
7 and Figures 9 through 16. For a specific example of how marketing
recommendations are translated into a final net advisory price that incorporates
similar parameters, please refer to the 1996 AgMAS Corn and Soybean Pricing
results of the 1995 wheat evaluations are contained in Table
4. This table shows the breakout of the components of the net advisory
price as well as the net advisory price itself. The average net advisory
price for all 24 programs is $3.79 per bushel. It is computed as the
unadjusted cash sales price ($4.11 per bushel) minus carrying charges
($0.18 per bushel) plus futures and options gains (-$0.12 per bushel)
minus brokerage costs ($0.01 per bushel).
The net advisory price is eighteen cents above the market benchmark price.
The range of net advisory prices is large, with a minimum of $3.01 per
bushel and a maximum of $4.71 per bushel.
results of the 1996 wheat evaluations are contained in Table
5. The average net advisory price for all 23 programs is $3.82 per
bushel. It is computed as the unadjusted cash sales price ($4.15 per
bushel) minus carrying charges ($0.23 per bushel) plus futures and options
gains (-$0.08 per bushel) minus brokerage costs ($0.01 per bushel).26
The net advisory price is thirteen cents below the market benchmark price.
The range of net advisory prices for 1996 increased as compared to 1995,
with a minimum of $2.74 per bushel and a maximum of $4.94 per bushel.
results of the 1997 evaluations are contained in Table
6. The average net advisory price for the 20 programs is $2.64 per
bushel. It is computed as the unadjusted cash sales price ($3.04 per bushel)
minus carrying charges ($0.45 per bushel) plus futures and options gains
($0.06 per bushel) minus brokerage costs ($0.02 per bushel).26
The net advisory price is fifty-eight cents per bushel below the market
benchmark price. The range of net advisory prices for 1997 increases
as compared to both 1995 and 1996, with a minimum of $1.34 per bushel
and a maximum of $3.90 per bushel.
results of the 1998 evaluation are contained in Table
7. The average net advisory price for the 21 programs is $2.36 per
bushel. It is computed as the unadjusted cash sales price ($2.46 per
bushel) minus carrying charges ($0.37 per bushel) plus futures and options
gains ($0.09 per bushel) minus brokerage costs ($0.02 per bushel) plus
LDP/MLG gain ($0.20 per bushel). The net advisory price is fifty-four
cents per bushel below the market benchmark price. The range of net advisory
prices for 1998 decreased somewhat compared to 1996 and 1997, with a minimum
of $1.34 per bushel and a maximum of $3.33 per bushel.
A point to consider
when examining Tables 4, 5,
6 and 7 is the impact of the assumption that all storage occurs off-farm.
It is possible to argue that short-run marginal costs of on-farm wheat
storage are zero if the facilities already exist and variable costs associated
with handling wheat and maintaining grain quality are not included. Excluding
the costs of commercial storage entirely (but continuing to subtract interest
costs), the average net advisory price increases to $3.88
per bushel in 1995, $3.94 in 1996, $2.90 in 1997, and $2.59 per bushel
in 1998. The calculation of the market benchmark price also is impacted
by such a change in the storage cost assumption. The market benchmark
price increases to $3.66 per bushel for 1995, $3.99 for 1996, $3.31 for
1997 and $2.97 per bushel for 1998. Therefore, if physical storage charges
are assumed to be zero, the average net advisory price would be $0.22
above the market benchmark price for 1995, $0.05 under for 1996, $0.41
under for 1997, and $0.38 under for 1998.
of the net advisory prices is illustrated in Figures
9, 10, 11 and 12. For the 24 wheat programs for 1995, four achieve
a net price that is within (plus or minus) $0.20 of the market benchmark
price of $3.61 per bushel. Ten of the advisory programs achieve a net
price $0.21 to $0.61 higher than the market benchmark price, two programs
achieve a net price of $0.62 to $1.02 above the market benchmark and one
program beats the benchmark price by more then $1.03. Seven programs
are grouped in a range between $0.21 and $0.61 below the market benchmark
the 23 wheat programs in the 1996 evaluation, eleven are within (plus
or minus) $0.25 per bushel of the market benchmark price of $3.95 per
bushel. Three of the advisory programs achieve a net price between $0.26
and $0.76 higher than the market benchmark price, and one program achieves
a net price of more than $0.77 above the market benchmark. Four programs
are grouped in a range between $0.26 and $0.76 below the market benchmark
price, with four programs more than $0.77 below the market benchmark.
For the 20 wheat
programs for 1997 wheat, five achieve a net price that is within (plus
or minus) $0.25 of the market benchmark price of $3.22 per bushel. Two
of the advisory programs achieve a net price $0.26 or higher than the
market benchmark price. Four programs are grouped in a range between
$0.26 and $0.76 below the market benchmark price, seven services are in
a range between $0.77 and $1.27 below the benchmark, one service is in
a range between $1.28 and $1.78 below the benchmark price, and one service
is in a range between $1.79 and $2.29 below the benchmark price.
the 21 wheat programs in the 1998 evaluation, four are within (plus or
minus) $0.23 per bushel of the market benchmark price of $2.90 per bushel.
One of the advisory programs achieves a net price between $0.24 and $0.70
higher than the market benchmark price. Nine programs are grouped in a
range between $0.24 and $0.70 below the market benchmark price, with six
programs in a range from $0.71 to $1.17 below the market benchmark, and
one program that is more then $1.18 below the benchmark.
Another view of the
pricing performance of the advisory programs is shown in Figures
13, 14, 15, and 16.
Here, net advisory prices are ranked from highest to lowest and plotted
versus the market benchmark. Sixteen of the 24 wheat marketing programs
in 1995 achieve a net price that is equal to or higher than the market
benchmark price. Nine wheat marketing programs beat the market benchmark
in 1996. Four programs beat the benchmark in 1997 and one service outperforms
the market benchmark in 1998. Note that the same advisory programs do
not necessarily exceed the market benchmarks in each of the comparisons
in Figures 13, 14, 15, and 16.
17 shows the pattern of wheat prices for the 1995 marketing window.
The top chart shows daily cash prices from June 1, 1994 through May 31,
1996. The pre-harvest prices are the forward contract prices for harvest
delivery. The second chart offers a different perspective, in that during
the post-harvest period the daily cash price is adjusted for cumulative
carrying costs (interest and storage charges). This shows that prices
for the 1995 crop are highest in the post-harvest period with prices reaching
well over $5.50 in late April and early May of 1996. This is due to a
lower than trend yield for 1995 and the realization that 1996 is also
going to be a low yielding year. While some advisory services sold early
in the crop year, many held the crop and captured the high April and May
18 shows the pattern of wheat prices for the 1996 marketing year from
June 1, 1995 to May 31, 1997. Again, the first chart shows the price
series with the pre-harvest forward contract and the post-harvest cash
price, while the second graph incorporates the cost of carry. This shows
the increasing cash price as low yields expectations pushed the pre-harvest
cash price over $5.50, then the decline to the $3.50 level as the potential
for the 1997 crop is finally realized in late May. The same 1996 high
in April and May that created an opportunity for those holding the 1995
crop also spurred some advisory services to forward contract expected
19 shows the effects of a large crop hitting the marketplace. Forward
contract bids reflected the low yields of the 1996 harvest, but prices
dipped below $3.00 by August 1997. The situation worsens as the full
impact of the Asian economic situation begins to slow exports throughout
the second half of the 1997 marketing period. Unfortunately, many advisors
held wheat, perhaps hoping for an end of the year windfall such as in
1995. However, the potential for good yields in all classes for 1998
causes prices to decline further.
20 incorporates the LDP and MLG rates for the 1998 marketing period.
The first graph shows the pre-harvest bids and then the post-harvest cash
price. The middle graph shows the impact of the LDP and MLG on the net
price available to producers. The third graph shows the impact of both
LDP and carry on the market. There are good pricing opportunities prior
to harvest, with bids at some times above $3.50. However, a trend line
yield for soft red winter wheat and larger then trend for hard red winter
and hard red spring wheat, coupled with lower then anticipated exports,
results in prices below the loan rate for most of the remainder of the
marketing period. LDPs and MLGs are minimal at harvest, but increase
as harvest progresses in the hard red winter and hard red spring wheat
areas, at times reaching over $0.60. Those advisors who chose forward
contracting are rewarded as prices continue to slide. Some of the services
chose to speculate on the LDP as it appeared to disappear during corn
and soybean harvest, only to see prices sink to new lows, and no chance
of even receiving the loan rate for wheat.
Average Pricing Performance Results for the Advisory Programs
A summary of the results of the pricing performance evaluations for the 1995,
1996, 1997 and 1998 wheat marketing periods is contained in Tables
8 and 9 and Figures 21 through 23.
Tables 8 and 9 present pricing results for each year along with two-year averages
(1997-1998), three-year averages (1996-1998) and four-year averages (1995-1998). Some marketing programs are not included in
all of the averages. For example, four-year averages are calculated only for
the 18 marketing programs that are evaluated for all four years. The following
discussion focuses on the four-year average results.
As shown in Table 8, the average net advisory wheat price over the four years
for the 18 programs is $3.15 per bushel, $0.27 below the four-year market benchmark
price of $3.42 per bushel. The results range from a low of $2.76 to a high of
$3.48 per bushel.
The four-year results for advisory wheat revenue are presented in Table 9.
At first glance, revenue results appear to be redundant with the net price results.
However, annual yield variation may cause average revenue and average price results
to differ across services. In particular, the impact of the relatively good and
poor pricing performance may be reduced or exaggerated depending on whether it
is associated with large or small wheat crops. The average advisory revenue for
the four years is $151 per acre. This is $16 per acre lower than the four-year
market benchmark revenue. The results range from $134 to $172 per acre.
For comparison purposes, the annual subscription cost of each advisory program
also is listed in Table 9. Subscription costs average $294 per program, about
twice the average advisory revenue for one acre of production. Subscription costs
do not appear to be large relative to total farm revenue, whether a large or small
farm is considered. For a 1,000 acre farm, subscription costs average about two-tenths
of one percent of total advisory revenue. For a 250 acre farm, subscription costs
average about eight-tenths of one percent of total advisory revenue. Note that
subscription costs are not subtracted from the revenue figures presented in Table
As shown in the top chart in Figure 23, only 2 of the 18 wheat-marketing programs
achieve a four-year average net advisory price that is above the four-year average
market benchmark price of $3.42 per bushel. The bottom chart in Figure 23 shows
the comparison of the four-year average advisory revenue versus the four-year
average revenue implied by the market benchmark price. Two of the 18 advisory
programs achieve a four-year average revenue that is above average market benchmark
revenue of $167 per acre.
A First Look at Pricing
Performance and Risk of the Advisory Programs
program’s net price received is an important indicator of performance.
However, pricing performance almost certainly is not the only relevant
indicator. For example, two advisory programs may generate the same average
net price across marketing periods, but the risk of the programs may differ
substantially. The difference in risk may be the result of: i) type of
recommended pricing tool (cash, cash forward, futures, options, etc.);
ii) timing of sales; and iii) implementation of marketing strategies.
to quantify the risk of advisory programs, a definition of risk must be
developed. Risk is usually thought of as the possibility or probability
of loss. A natural extension of this idea looks at risk as the chance
producers will fail to achieve the net price they expect based on following
an advisory program. This approach to quantifying risk does not measure
the possibility of loss alone. Risk is seen as uncertainty – the likelihood
that what is expected will fail to happen, whether the outcome is better
or worse than expected. So an unexpected return on the upside or the
downside – a net price of $3.50 or $2.50 per bushel when a net price of
$3.00 per bushel is expected – counts in determining the “risk” of an
advisory program. Thus, an advisory program whose net price does not
depart much from its expected, or average, net price is said to carry
little risk. In contrast, an advisory program whose net price is quite
volatile from year-to-year, often departing from expected net price, is
said to be quite risky.
to defining risk can be quantified by using a statistical measure called
the standard deviation.
It measures the dispersion of year-to-year net advisory prices from the
average net price. One can think of the standard deviation as the “typical”
variation in net price from year-to-year. The larger the standard deviation
of an advisory program, the less likely a producer is to get exactly the
net price expected, though it is possible by chance to get a higher price
instead of a lower one for any particular time period.
analysis of market advisory pricing performance and risk will provide
valuable information to producers. However, as economic theories of decision-making
under risk highlight, it is the tradeoff between pricing performance and
risk that is likely to be of greatest interest to producers. Theory suggests that above-average pricing performance
should be possible only if marketing strategies are recommended that have
above-average risk (and vice versa). Faced with such a choice
set, producers will choose an advisory program that has a pricing-risk
tradeoff that is consistent with their risk preferences.
data needed for assessing the pricing-risk tradeoff of market advisory
programs is presented in Table 10. For each advisory program tracked
in all four years of AgMAS evaluations, the four-year average and standard
deviation of net price or revenue is reported. The standard deviations
indicate that the risk of advisory programs varies substantially. In
wheat, the standard deviations range from a low of $0.20 per bushel to
a high of $1.70 per bushel. The average standard deviation across the
18 wheat programs is $0.86 per bushel, which is substantially higher than
the $0.46 per bushel standard deviation of the wheat market benchmark.
Finally, revenue standard deviations for the 18 programs range from a
low of $16 per acre to a high of $58 per acre. The average revenue standard
deviation across the 18 programs is $33 per bushel, which is somewhat
higher than the $29 per acre standard deviation of the market benchmark.
The smaller difference in the standard deviations for revenue is due to
the fact that the advisory services as a whole did much better in short
crop years compared to large crop years. Therefore, when price performance
is multiplied by yield, the standard deviation is not as large because
a high price is multiplied by a low yield and a low price is multiplied
by a high yield, resulting in less variation.
relationship between pricing performance and risk for wheat is presented
in Figure 24. Contrary
to what economic theory predicts, there is a negative tradeoff between
the average price and standard deviation; securing a higher net wheat
price generally requires that an advisory program take on less risk, and
vice versa. The strength of the relationship is measured by the
correlation coefficient, which can take on values between –1 and +1.
A negative value means that net price and standard deviation tend to move
in opposite directions, while a positive value means they tend to move
in the same direction. The closer a correlation coefficient is to –1
or +1, the stronger the tendency. Since the estimated correlation coefficient
for wheat is -0.26, a modestly negative relationship is indicated.
implications for wheat of the tradeoff between pricing performance and
risk are explored in Figure
25. The chart is the same as in Figure 24, except it is now divided
into four quadrants based on the average price and standard deviation
of the market benchmark. Advisory programs in the upper left quadrant
have a higher price and less risk than the benchmark, which is the most
desirable outcome from a producer’s perspective. Advisory programs in
the lower right quadrant have a lower price and more risk than the benchmark,
which is the least desirable outcome from a producer’s perspective. The
two remaining quadrants reflect either a higher price and more risk than
the market benchmark or a lower price and less risk than the market benchmark.
A producer may prefer an advisory program to the market benchmark in either
of these two quadrants, but this depends on personal preference for risk
relative to return.
plotted in Figure 25 show there is only one advisory program in wheat
that generates a combination of net price and risk superior to the market
benchmark (upper left quadrant). In contrast, fifteen advisory programs
in wheat produce a combination that is inferior to the benchmark (lower
right quadrant). Only one program has a lower price and less risk than
the benchmark, while one program has a higher price and more risk.
The estimated relationship
between performance and risk for wheat revenue is presented in Figure
26. There is a slightly
negative tradeoff between the average revenue and standard deviation.
The estimated correlation coefficient for revenue is +0.03, indicating
a neutral relationship between average revenue and risk.
Based on revenue,
the data plotted in Figure 27
show that no advisory program generates a combination of average revenue
and risk superior to the market benchmark (upper left quadrant). Eleven
advisory programs produce a revenue combination that is inferior to the
benchmark (lower right quadrant). Five programs have lower revenue and
less risk than the benchmark, while two programs have higher revenue and
on financial investments suggests that return-risk results, like those
presented above, may be sensitive to alternative specifications of the
market benchmark. To investigate this issue, the pricing (or revenue)
performance and risk of market advisory programs is compared to the 20-month
average cash price benchmark discussed earlier in the “Benchmark Prices”
section. These results are found in Figures
28 through 31. Compared to the 24-month benchmark, the 20-month benchmark
simply deletes the first four months of each marketing window from the
computations of the benchmark price. The change barely impacts the average
benchmark price or revenue for the four years of analysis. As noted earlier,
this is not surprising given the nature of the average cash price benchmarks.
In informationally efficient markets, annual averages of different average
cash price benchmarks should be roughly similar when stated on a harvest
equivalent basis. The same logic does not necessarily carry over to the
standard deviations of the alternative benchmarks. In this case, standard
deviations for the 20-month benchmark are higher than those of the 24-month
benchmark (see Table 3).
The higher standard deviations for the 20-month benchmark do make sense,
given that the 20-month benchmark includes less pre-harvest forward contracting
than the 24-month benchmark. It is interesting to note that the standard
deviation for revenue is only slightly higher for the 20-month benchmark.
The comparisons in
Figures 28 through 31 indicate that the risk-return performance of market
advisory programs is not very sensitive to the change in market benchmarks.
Figure 28 shows that there is still a negative correlation between price
and standard deviation, though slightly less negative then that using
the 24-month benchmark. Figure 29 shows there are five services that
have lower price and lower risk and only 11 that have a lower price and
higher risk. Figure 28 and 29 show that there is some sensitivity to
the benchmark. However, Figure 30 and 31 show that there is much less
sensitivity in revenue, in that the only change in either graph is a slight
change in the correlation in Figure 30.
While there may be
some sensitivity of the return-risk results to alternative benchmarks,
it is important to emphasize that the basic findings are unchanged. Whether
a 24-month or 20-month benchmark is considered, about two-thirds of the
advisory programs generate average prices and risk in the low price/high
risk quadrants. Contrary to theory, over this four-year period, taking
a higher risk did not necessarily lead to high prices and vice versa.
The results presented
in this section suggest performance analysis is little affected by the
inclusion of risk. Whether one-dimension of performance, average price,
or two-dimensions, average price and risk, are considered, the implications
of the results are similar. Specifically, few wheat advisory programs
“beat the market.” This overall conclusion is not sensitive to the benchmark
used in this analysis.
It is important to
emphasize at this point that the pricing and risk performance results
are based on only four observations. This is a small sample for estimating
the true risks of market advisory programs. Hence, the results presented
in this section should be viewed as exploratory rather than definitive.
Finally, the approach
to performance evaluation presented in this section opens the door to
a new type of analysis. Modern Portfolio Theory (MPT) shows how to combine
market advisory programs into “portfolios” that have the highest return
for a given level of risk. A “portfolio” might consist of 50 percent
of wheat marketed by advisory program X and 50 percent marketed
by advisory program Y. MPT produces “efficient portfolios” by
taking advantage of the diversification opportunities available through
combining advisory programs. In fact, it is possible that some portfolios
of advisory programs will generate higher prices and less risk than the
market benchmark (lie in the upper left quadrant of Figures
25 or 27), even though the individual advisory programs that make
up the portfolio do not. The potential improvement in performance depends
on the degree to which net advisory prices do not tend to move
together. The application of MPT to market advisory services represents
an interesting area of future research for the AgMAS Project.
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