Academic journal article Journal of Agricultural and Resource Economics

Explaining Variations in the Price of Dairy Quota: Flow Returns, Liquidity, Quota Characteristics, and Policy Risk

Academic journal article Journal of Agricultural and Resource Economics

Explaining Variations in the Price of Dairy Quota: Flow Returns, Liquidity, Quota Characteristics, and Policy Risk

Article excerpt

An econometric model based on the net present value model is used to examine factors that drive the variation of California dairy quota values over a 29-year period. The results suggest the price of quota is based on expected returns, variations in quota owner liquidity, and the risk of policy default. The dominant influence on the variation of the quota price was the historical variation in monthly flow of net benefits from owning quota. This analysis confirms that the rate of return to quota rises in periods of policy uncertainty.

Key words: adaptive expectations, capitalization of policy, dairy policy, policy risk, quota

Introduction

The expected value of policy benefits is capitalized into the asset prices of inelastically supplied resources. This basic principle is well accepted, but the capitalization rate has been particularly hard to measure for assets created by agricultural policies for several reasons: policies are complex and change over time, non-policy factors typically affect the value of farm assets associated with policy, and sufficient market data measuring farm asset prices are often not available.

Understanding how policy benefits are capitalized into agricultural assets is vital to assessing how policy affects welfare. Land has received most of the attention in the literature about capitalization into farm assets (Alston, 1986; Lence and Miller, 1999). For example, researchers have determined that part of the capital value of some farm policy benefits is included in farmland values (Duffy et al., 1994; Clark, Klein, and Thompson, 1993; and Seagraves, 1969, among others). However, because farmland markets are complex with multiple influences, researchers have found it difficult to measure the contribution of farm policy to farmland prices.

Other farm assets are actually created by farm policy itself. Unlike land and other capital assets such as animals, tractors, etc., policy-created assets exist solely at the will of the government. Another distinguishing feature of policy-created assets is that these assets seem to exhibit relatively high rates of return relative to alternative investments (e.g., Barichello and Chen, 1996; Chen and Meilke, 1998; Johnson, 1991; Lermer and Stanbury, 1985; Moschini and Meilke, 1988; Organization for Economic Cooperation and Development, 1996; Sumner, 1988; Sumner and Alston, 1984).

This analysis uses monthly data from a unique market for a farm policy-created asset to describe how program characteristics and policy events affect asset prices over a 29-year study period, 1970-1998. The rate of return to ownership of California dairy quota, about 27% per annum (the ratio of the sum of flow revenue earned plus capital gains relative to the quota price), has been substantially higher than the rate of return for stock market indices of 8.4% (return of the NYSE/AMEX/NASDAQ value-weighted market index) (Sumner and Wilson, 2000b).

Our data allow us to observe quota asset prices directly and to examine the influence of policy more directly and over a longer period than has been possible in previous studies. An econometric model based on simple net present value ideas is used to examine factors that drive the variation of quota values over time. Our results suggest the price of quota is based on expected returns, variations in quota owner liquidity, and the risk of policy default.

Literature on Quota Returns

Several studies have examined the movement of quota prices conceptually and empirically (e.g., Alston, 1992; Amis, 1978; Barichello, 1996; Hubbard, 1992; Johnson, 1991; Seagraves, 1969; Veeman and Dong, 1995). In his 1969 study of flue-cured tobacco acreage allotments, Seagraves used data on farmland prices and found that the ratio of the estimated value of the flow return to the asset value of tobacco allotment fell over the 20 years of the data set. Seagraves interpreted the decline as increased confidence in the allotment program-a decline in the risk of policy default. …

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