1999 Pricing Performance of Market Advisory Services for Wheat
Darrel L. Good, and Scott
H. Irwin *
2001 by Joao Martines-Filho, Darrel L. Good, and Scott H. Irwin. 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 service. 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 1999 wheat crop year. In order to evaluate
the returns to the marketing advice produced by the services, the Agricultural
Market Advisory Services (AgMAS) Project purchases
a subscription to each of the services included in the study. 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 AgMAS Project website (/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 some exceptions, the marketing window for the 1999 crop year
is June 1, 1998 through May 31, 2000; 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) and marketing loan gain (MLG) recommendations made by advisory
programs are followed wherever feasible and applicable.
The average net advisory
price across all 23 wheat programs in 1999 is $2.64 per bushel, $0.04
below the market benchmark price. The range of net advisory prices is
substantial, with a minimum of $2.18 per bushel and a maximum of $3.38
per bushel. The average revenue achieved by following an advisory service
is $163 per acre, $3.00 less than the market benchmark revenue. The spread
in advisory revenue also is noteworthy, with the difference between the
bottom- and top-performing advisory programs reaching almost $75 per acre.
The average net advisory
price achieved by following 17 wheat advisory programs over the 1995-1999
crop years is $3.06 per bushel, $0.21 below the five-year average market
benchmark price. The five-year average revenue is $154 per acre, $13
less than the five-year average market benchmark revenue. The advisory
prices range from a low of $2.79 to a high of $3.31 per bushel and revenue
from a low of $140 per acre to a high of $171 per acre.
An advisory program’s
net price or revenue received is an important indicator of performance.
The tradeoff between pricing performance and risk also is likely to be
of interest to producers. Contrary to the prediction of economic theory,
a slight negative tradeoff between average net advisory price and risk
is found. That is, producing higher net prices generally required that
an advisory program over 1995-1999 take on less risk, and vice versa.
Since the estimated correlation between price and risk is only –0.18,
this counter-intuitive result is likely due to random variation and is
not expected to persist over a longer sample. Only 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 average revenue and risk. It is important
to emphasize that the pricing and risk performance results are based on
five observations. This is a relatively small sample for estimating the
true risks of market advisory programs. Hence, the return-risk results
should be viewed as exploratory rather than definitive.
Introduction to the
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.
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: Dr. 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: email@example.com. The AgMAS project also has a website with the
following address: /agmas.
Funding for the AgMAS
project is provided by the following organizations: 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; the Risk Management Agency, U.S.
Department of Agriculture, and the Initiative for Future Agriculture and
Food Systems, 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 1999 wheat crop. Specifically, the net price
received by a subscriber to an advisory service is calculated for the
wheat crop harvested in 1999. With some exceptions, the marketing window
for the 1999 crop year is from June 1, 1998 through May 31, 2000. Another
purpose of this report is to compare the pricing performance results for
the 1999 wheat crop with previously released results for the 1995, 1996,
1997 and 1998 crop years.
A relevant question
is whether useful conclusions about pricing performance can be made based
on data from five crop years. From a purely statistical standpoint, samples
with five observations typically are considered small. This perspective
would suggest it is inappropriate to draw too many conclusions from the
available data on pricing performance. From a practical, decision-making
standpoint, samples with five observations often are considered adequate
to reach conclusions. A useful comparison in this context can be made
to university yield trials for crop varieties. As an example, the University
of Illinois Variety Testing program (http://www.cropsci.uiuc.edu/vt/)
presents only two-year or three-year averages of the yields for crop varieties
in the trials, and in many cases these cannot be computed because of turnover
in the varieties tested from year-to-year. Despite the limitations, this
type of yield trial data is widely used by farmers in making varietal
selections. On balance, then, it seems reasonable to argue that the five
years of data currently available on pricing performance may be used to
make some modest conclusions. Caution obviously is in order given the
possibility of results being due to random chance in a relatively small
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 Beurskens,
Director of Product Strategy for e-markets; Jeffrey A. Brunoehler, Market
President of the AMCORE Bank in Mendota, Illinois; Renny Ehler, producer
in Champaign County, Illinois; Chris Hurt, Professor in the Department
of Agricultural Economics at Purdue University; Terry Kastens, Associate
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 market
advisory service recommendations. The following section describes the
methods and assumptions used to calculate the returns to marketing advice.
The third section of the report presents 1999 pricing results. The fourth
section presents a summary of the combined results for the 1995, 1996,
1997, 1998 and 1999 crop years. The final section presents results on
the tradeoff between pricing performance and risk of market advisory services.
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 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
cash sales. 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., 1999 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 that 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.
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.
in a previous AgMAS report suggests 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 among 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 1, 1998 through May 31, 2000, is used
in the analysis. The beginning date is selected because it reflects a
time when 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 to the 1999
crop year. Five advisory programs had cash wheat unsold after May 31,
2000. These cash positions varied from 5 to 100 percent. Three of these
programs sold all wheat by the end of September 2000. The remaining two
programs sold the remaining wheat in January and March 2001, respectively.
In all of these cases, the actual recommendations on the indicated dates
are recorded and used in the analysis.
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.
Prices in this 19-county area best reflect prices for the assumed
geographic location of the representative southwest Illinois producer
(West Southwest Illinois Crop Reporting District).
collected by the Illinois Department of Ag Market News are used when available.
These bids are available for wheat from December 18, 1998 through June
2, 1999. Since the marketing window for the 1999 wheat crop begins in
June 1998, and the Illinois Department of Ag Market News did not begin
reporting actual cash forward bids until December 18, 1998, pre-harvest
prices need to be estimated for the first few months of the marketing
window. For a date between June 1, 1998 and December 17, 1998, a two-step
estimation procedure is adopted. First, the forward basis for the period
in question is estimated by 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 added from the settlement price of the
Chicago Board of Trade (CBOT) 1999 July wheat futures contract between
June 1, 1998 and December 17, 1998. 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 1999 crop year, none of services recommended post-harvest forward
contracts. In the future, if forward contracts recommended by advisory
programs either do not match the delivery periods reported by the Illinois
Department of Ag Market News or are made after the Illinois Department
of Ag Market News stops reporting post-harvest forward contract prices,
the following procedure will be used to estimate the post-harvest forward
contract prices needed in the analysis. First, three elevators in southwest
Illinois who agreed to supply data on spot and forward contract prices
on the dates when advisors made such recommendations will be contacted.
Each of these elevators is in a different county in the West Southwest
Illinois Crop Reporting District. Second, the spread between each elevator’s
forward price and spot price will be calculated for the relevant date.
Third, the forward spread will be averaged across the three elevators
for the same date. Fourth, the average forward spread from the three
elevators will be added to the southwest Illinois cash price (discussed
at the beginning of the section) to arrive at an estimated post-harvest
forward contract price for central Illinois.
The fill prices for
futures and options transactions generally are the prices reported by
the programs. 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 1999 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.
Prior to harvest, the best estimate of the current year’s expected yield
is likely to be a function of yield in previous years. In this study,
the assumed yield prior to harvest is the calculated trend yield, while
the actual reported yield is used from the harvest period forward. The
expected yield is based upon a linear regression trend model of actual
yields from 1972 through 1998 for the West Southwest Illinois Crop Reporting
District. Previous research suggests a regression trend model produces
relatively accurate yield forecasts.
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 harvest.
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, 1998 and 1999 are classified as “normal” crop years
and 1996 is classified as a “short” crop year.
In southwest Illinois,
the expected 1999 yield for wheat is calculated to be 54.42 bushels per
acre (bpa). Therefore, recommendations regarding the marketing quantity
made prior to harvest, are based on yields of 54.42 bpa. For example,
a recommendation to forward contract 20 percent of expected 1999 production
translates into a recommendation to contract 10.88 bpa (20 percent of
54.42). The actual reported wheat yield in southwest Illinois in 1999
is 62 bpa.
It is assumed that
after harvest begins, producers have reasonable ideas of what their actual
realized yield will be. Since harvest occurs at different dates each
year, estimates of harvest progress as reported by NASS in southwest Illinois
are used. Harvest progress estimates typically are not made available
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 1999, the harvest period for wheat is defined as June 18, 1999 through
July 8, 1999. Therefore, recommendations made after June 18 are applied
on the basis of the actual yield of 62 bpa.
The issue of changing
yield expectations typically is not dealt with in the recommendations
of the advisory programs. 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 time frame. Hence, an adjustment in yield assumptions from
expected to actual levels must be applied to cash transactions at some
point in time. In this analysis, an adjustment is made in the amount
of the first cash sale made after the beginning of the harvest period.
For example, if a program advises forward contracting 50 percent of the
wheat crop prior to harvest; this translates into sales of 27.21 bpa (50
percent of 54.42). However, when the actual yield is applied to the analysis,
sales-to-date of 27.21 bpa imply that only 43.89 percent of the actual
crop has been contracted ([27.21/62]*100). 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 1999 crop, making the total recommended sales 60 percent
of the crop, the recommendation is adjusted to 16.11 percent of the actual
yield (9.99 bushels), so that the total crop sold to date is 60 percent
of 62 bushels per acre (27.21 + 9.99 = 37.2 = 0.6*62). After this initial
adjustment, subsequent recommendations are taken as percentages of the
62 bpa actual yield, so that sales of 100 percent of the crop equal sales
of 62 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 1999 contract for 25 percent of the 1999 crop prior
to harvest. Since the amount hedged is based on the trend yield assumption
of 54.42 bpa, the futures position is 13.61 bpa (25 percent of 54.42).
After the yield assumption is changed, this amount represents a short
hedge of 21.95 percent ([13.61/62]*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 is 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
1999 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.
Most of the advisory
programs tracked by the AgMAS Project for the 1999 crop year 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
to $2.10 per bushel, the LDP will decrease to $0.40 per bushel. Conversely,
if the PCP decreases to $1.90 per bushel, the LDP will increase to $0.60
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 1999 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 1999 marketing
year since the PCP, late in the marketing year, 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 1999 crop, the sum of LDPs plus marketing
loan gains for all crops was subject to a payment limitation of $150,000
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
rate for the 1999 wheat crop 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 were below that rate during
the entire post-harvest period for the 1999 crop. This is reflected in
Figure 3, which shows the average wheat LDP or MLG rates for the West
Southwest Illinois Crop Reporting District during the 1999 marketing year.,
 LDPs or MLGs vary during harvest, from $0.40
to $0.50 per bushel, and then rise to $0.70 during summer. It declines
in the middle of September 1999 to $0.10 and increases to a level at or
above $0.25 for most of the remainder of the marketing year. In the beginning
of May 2000, it falls to almost zero and then recovers at the end of the
month to $0.20.
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 the crop 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.
1 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 27.21 bpa when the percentage is applied to expected production (0.50*54.42
= 27.21). Next, convert the bpa to a percentage of actual production,
which is 43.89 percent ([27.21/62]*100) = 43.89). To determine the LDP
payment on the 43.89 percent of actual production forward contracted,
simply read down Table 1 to June 28, which is the date when 46.7 percent
of harvest is assumed to be complete. The average LDP up to that date
(June 18, 1999 to June 28, 1999) is $0.44 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, 2000 are not placed under
loan. Those crops receive program benefits through LDPs. After March
31, 2000, 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 1. 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 are fulfilled.
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
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
long put positions. Long put options positions established after
the crop is harvested are treated in the same manner as post-harvest
sales before March 31, 2000. If a spot cash sale of wheat is recommended
before March 31, 2000, it is assumed that the LDP, if positive, is established
that same day.
program after March 31, 2000. Since LDPs are not available after
March 31, 2000, 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, 2000). Note also that the $150,000 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 July 9, the first date after the end of the 1999 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 1999 wheat crops quoted in a telephone
survey of southwest Illinois elevators.
The interest rate
is assumed to be 9.0 percent for 1999 and is applied to the average harvest-time
price, which is $2.13 per bushel. 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, 2000, 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.
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 earlier 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 the 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.
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
For the 1999 crop year, the benchmark is based on the average price from
June 1, 1998 through May 31, 2000. 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 1999 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 "Yields and Harvest Definition"
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
to the average cash price benchmark is needed due to the operation of
the loan program. 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 1999 pre-harvest period according to the benchmark strategy (approximately
46 percent) are treated as forward contracts with the LDPs assigned at
harvest. LDPs for the forward cash prices were assumed to be $0.44 per
bushel. Bushels marketed each day in the 1999 post-harvest period (approximately
54 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 to reflect the assumption that stored grain is placed under loan.
Results for the Advisory Programs
results for the 1999 wheat crop are presented in Tables
2 and 3 and Figure 4. 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 Report.
results of the 1999 wheat evaluations are contained in Table
2. 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 23 programs is $2.64 per bushel. It is computed as the
unadjusted cash sales price ($2.28 per bushel) minus carrying charges
($0.23 per bushel) plus futures and options gains ($0.09 per bushel) minus
brokerage costs ($0.02 per bushel) plus LDP/MLG gain ($0.52 per bushel). The net advisory
price is $0.04 below the market benchmark price. The range of net advisory
prices is large, with a minimum of $2.18 per bushel and a maximum of $3.38
3 lists the program-by-program results of the wheat revenue analysis.
The average revenue achieved by following both the programs offered by
an advisory program is $163 per acre, $3 per acre below the market benchmark
revenue for 1999 crop year. The spread in advisory revenue also is especially
noteworthy, with the difference between the bottom- and top-performing
advisory programs reaching almost $75 per acre.
For comparison purposes,
the annual subscription cost of each advisory program is listed in the
last column of Table 3. Subscription costs
average $330 per program, about equal to the average advisory revenue
for two acres of production. Subscription costs do not appear to be substantial
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 average 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 any of the revenue
figures presented in Table 2.
Another view of the
pricing performance of the advisory programs is shown in Figure
4. Here, net advisory prices or revenues are ranked from highest
to lowest and plotted versus the market benchmark. As shown in the charts,
6 of the 23 wheat marketing programs achieve a net price and net revenue
that are equal to or higher than the market benchmark price or revenue
for the 1999 crop.
5 shows the pattern of wheat prices for the 1999 crop year. The top
chart shows daily cash prices from June 1, 1998 through May 31, 2000.
The pre-harvest prices are the cash forward contract prices for harvest
delivery. The middle chart is a repeat of the top chart with daily LDP
or MLG added to the daily prices. For the pre-harvest period, the LDP
is the average LDP available at harvest time ($0.44 per bushel). The
third 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). The chart illustrates the pattern of
harvest equivalent prices plus LDP or MLG. There were some pricing opportunities
prior to harvest, with bids between $2.50 and $3.10 per bushel until January
1999. However, a trend line yield for soft red winter wheat and above
trend for hard red winter and hard red spring wheat, coupled with lower
than anticipated exports, resulted in prices below the loan rate for most
of the remainder of the marketing period. Those advisors who chose early
forward contracting were rewarded. Some of the services chose to establish
the LDP at harvest and hold the crop unpriced. This strategy was not
successful since the post-harvest price recovery did not exceed the cost
Pricing Performance Results for the Advisory Programs
A summary of the
results of the pricing performance evaluations for the 1995 through 1999
wheat crop years is contained in Tables 4 through
7 and Figures 6 through 9. The results for the 1995 through 1998
crop years are those contained in the 1998 AgMAS Wheat Pricing Report. Tables 4 and
6 present pricing or revenue results for each year, while Tables 5
and 7 show two-year averages (1998-1999), three-year averages (1997-1999),
four-year averages (1996-1999), and five-year averages (1995-1999). Some marketing programs are not included in
all of the averages. For example, the five-year average is calculated
only for the 17 marketing programs that are evaluated for all five years.
The following discussion focuses on the five-year average results.
As shown in Table
5, the average net advisory wheat price over the five years for the
17 programs is $3.06 per bushel, $0.21 below the five-year market benchmark
price of $3.27 per bushel. The results range from a low of $2.79 to a
high of $3.31 per bushel.
The five-year results
for advisory revenue are presented in Table
7. The average advisory revenue for the five years is $154 per acre.
This is $13 per acre below the five-year market benchmark revenue. The
results range from a low of $140 to a high of $171 per acre.
As shown in the top
chart in Figure 9, only 1 of the 17 wheat
marketing programs achieve a five-year average net advisory price that
is above the five-year average market benchmark price of $3.27 per bushel.
The bottom chart in Figure 9 shows the comparison
of the five-year average advisory revenue versus the five-year average
revenue implied by the market benchmark price. Only 1 of the 17 advisory
programs achieve a five-year average revenue that is equal or above average
market benchmark revenue of $167 per acre.
and Risk of the Advisory Programs
advisory 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, forward, futures, options, etc.), ii)
timing of sales, and iii) implementation of marketing strategies.
order 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 $3.00 or $2.00 per bushel when a net price of
$2.50 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.
This approach 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
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.
The basic data needed
for assessing the pricing-risk tradeoff of market advisory programs is
presented in Table 8. For each advisory
program tracked in all five years of AgMAS evaluations, the five-year
average net advisory price or revenue and standard deviation of net advisory
price or revenue are reported. The standard deviations indicate that
the risk of advisory programs varies substantially. The standard deviations
of the net advisory prices range from a low of $0.24 per bushel to a high
of $1.47 per bushel. The average standard deviation across the 17 wheat
programs is $0.82 per bushel, which is higher than the $0.52 per bushel
standard deviation of the wheat market benchmark. Revenue standard deviations
for the 17 programs range from a low of $18 per acre to a high of $56
per acre. The average revenue standard deviation across the 17 programs
is $31 per bushel, higher than the $25 per acre standard deviation of
the market benchmark.
The performance implications
of the tradeoff between wheat pricing performance and risk are explored
in Figure 11. The chart is the same as
in Figure 10, 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 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.
The data plotted
in Figure 11 show that 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 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 no program has a higher price
and more risk.
The estimated relationship
between performance and risk for wheat revenue is presented in Figure
12. There is virtually no tradeoff between 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 13 show that
no advisory program generates a combination of average revenue and risk
superior to the market benchmark (upper left quadrant). Twelve advisory
programs produce a revenue combination that is inferior to the benchmark
(lower right quadrant). Four programs have lower revenue and less risk
than the benchmark, while only one program has higher revenue and more
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 a 20-month
average cash price and revenue benchmarks in Figures
14 and 15. 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 has limited impact on
the average benchmark price or revenue for the five years of analysis.
The average 20-month benchmark price is $3.26 per bushel, compared to
$3.27 per bushel for the 24-month benchmark. For revenue, the average
20-month benchmark revenue is $165 per acre, compared to $167 per acre
for the 24-month benchmark. The small differences are 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 previous logic
does not necessarily carry over to the standard deviations of the alternative
benchmarks. Standard deviations for the 20-month benchmark price should
be higher than those of the 24-month benchmark because the 20-month benchmark
includes less pre-harvest forward contracting than the 24-month benchmark.
All else equal, less pre-harvest forward contracting should lead to increased
risk. The standard deviation estimates are consistent with this logic.
The standard deviation for 20-month benchmark price is $0.64 per bushel,
compared to $0.52 per bushel for the 24-month benchmark. The same logic
may not apply for revenue, due to the relationship of the component risks,
price and yield. When price performance is multiplied by yield, the standard
deviation tends to not be as large because a high price generally is multiplied
by a low yield and a low price generally is multiplied by a high yield,
resulting in less variation. The standard deviation for 20-month benchmark
revenue is $23 per acre, compared to $25 per acre for the 24-month benchmark.
results may be somewhat sensitive to alternative benchmarks, it is important
to emphasize, whether a 24-month or 20-month benchmark is considered,
about three-quarters of the advisory programs generate average price and
risk in the low price/high risk quadrant. Contrary to the theory, over
this five-year crop years, taking a higher risk did not lead to higher
prices and vice versa.
In sum, 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, wheat advisory
programs rarely “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 five observations. This is a relatively small sample
for estimating the true risks of market advisory programs. Hence, the
results presented in this section should be viewed as exploratory rather
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 an advisory program X and 50 percent marketed
by an 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
11 and 13), 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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