Academic journal article Journal of Agricultural and Applied Economics

Portfolios of Agricultural Market Advisory Services: How Much Diversification Is Enough?

Academic journal article Journal of Agricultural and Applied Economics

Portfolios of Agricultural Market Advisory Services: How Much Diversification Is Enough?

Article excerpt

This study analyzes the potential risk-reduction gains from naive diversification among market advisory services for corn and soybeans. The total possible decrease in risk through naive diversification is small, mainly because advisory prices are highly correlated on average. Moreover, because marginal risk-reduction benefits decrease rapidly with size and the cost of holding the portfolios increases linearly due to services' subscription fees, it is optimal to limit portfolio size to a few advisory programs. Based on certainty equivalent measures and two representative risk-aversion levels, preferred portfolio sizes are between one and three programs.

Key Words: corn, diversification, market advisory service, portfolio, soybeans

JEL Classifications: G11, Q10, Q12, Q14

Marketing decisions are an important part of farm business management. Farmers are interested in enhancing farm income and reducing income variability when marketing crops. There are many tools to assist farmers in such marketing decisions. Several surveys, including Patrick, Musser, and Eckman and Schroeder et al., report that farmers specifically viewed one of these tools, professional market advisory services, as an important source of marketing information and advice. For a subscription fee, market advisory services offer specific advice to farmers on how to market their commodities. It is often thought that advisory services can process market information more rapidly and efficiently than farmers to determine the most appropriate marketing decisions.

Several studies have analyzed the effectiveness of market advisory services. Gehrt and Good examined the returns for corn and soybean producers, assuming they had followed the recommendations of five advisory services over 1985-1989 and compared returns against a market benchmark price. They concluded that there is some evidence that services could beat the benchmark price. Martines-Filho analyzed the preharvest recommendations of six advisory services for corn and soybeans over the 1991-1994 production years and found evidence supporting the ability of the services to generate a higher return than a market benchmark. In 1994, the Agricultural Market Advisory Services (AgMAS) Project was initiated at the University of Illinois to expand research on market advisory service performance. The AgMAS Project has monitored and evaluated about 25 advisory services each crop year, and the empirical findings have been disseminated through various AgMAS research reports. For example, Irwin, Martines-Filho, and Good presented results from the evaluation of corn and soybean advisory services over 1995-2000. When both average price and risk were considered, only a small fraction of services performed better than the average price offered by the market. On the other hand, a majority of the services performed better than the average price received by farmers as reported by the U.S. Department of Agriculture (USDA).

The research reviewed above examines the pricing performance of market advisory services on a stand-alone basis only. In other words, individual advisory services are evaluated against benchmark prices without analyzing possible gains from diversification among these services. In reality, farmers can choose more than one advisory service and market a proportion of production following the advice of each of the selected services. According to survey results reported by Isengildina et al., farmers that subscribe to advisory services often subscribe to multiple services. The sample for this survey was drawn from Midwest, Great Plains, and southeastern U.S. producers who subscribed to a satellite information delivery service that offers electronic delivery of advisory-service recommendations. Survey results show that 57% of the farmers subscribed to two or more services and 20% subscribed to three or more services. Moreover, in recent years, several grain companies developed and began offering contracts where grain is priced according to the recommendations of an advisory service (e. …

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