An assessment of farmer’s exposure to risk and policy impacts on farmer’s risk management strategy 4 September September th EAAE seminar Shingo Kimura Trade and Agriculture Directorate

OECD Trade & Agriculture Directorate 2  What are the sources of risks that individual farmer is facing and what kind of correlations are they making use of? - Statistical analysis of risk exposure of individual farm from micro data (crop farm in Germany)  How farmers respond to different risk related measures and what kind of trade-offs that the government and farmer face in terms of risk and welfare? - Simulation analysis of risk management strategies and policies Main objectives of the farm level analysis of risk

OECD Trade & Agriculture Directorate 3 An assessment of farmer’s exposure to risk - Statistical analysis -

OECD Trade & Agriculture Directorate 4 Micro data from Germany  Data source German national FADN data  Selection criteria Single crop farms that cultivated more than 50 ha and have more than 60% of production from crops between 1995/96 and 2006/07 (12 years)  Sample size A panel of 232 crop farms are identified from 3 regions (77 from North, 41 from Centre/South and 141 from East)  Data coverage Yield, output price and planted area for 6 crops Costs, revenue, net farm income and labor inputs for a whole farm  Statistical information Mean and variability (distribution of variance-covariance matrices) by each region

OECD Trade & Agriculture Directorate 5 Risk exposure: Yield variability Higher yield variability at farm level data - Yield is location specific and favorable yield in one place is offset by the unfavorable yield in another place in the aggregated data (= special aggregation bias). Coefficient of variation of wheat yield *The bracket indicates the mean plus minus the standard deviation of the coefficient of variation across farms.

OECD Trade & Agriculture Directorate 6 Risk exposure: Price variability Higher price variability at farm level data, but to less extent - Price is less location specific and the integration of output market equalize the price across locations. - If compared at the aggregated level, price risk may seem larger than the yield risk Coefficient of variation of wheat price

OECD Trade & Agriculture Directorate 7 Risk exposure: Price-yield correlation Lower yield-price correlation at farm level data, but still significant (around -0.2). -Highly negative correlation may not improve the welfare of risk averse farmer because it may reduce the expected revenue. Coefficient of correlation of wheat price and yield Values are expressed in negative terms

OECD Trade & Agriculture Directorate 8 Risk management strategies and policies -Stochastic simulation analysis-

OECD Trade & Agriculture Directorate 9 Stochastic simulation model uncertain output price of crop i uncertain yield of crop i variable production cost of crop i area of land allocated to crop i transfer from government or benefit from risk market strategy level of coverage decided by farmer Farmer maximize his expected utility subject to profit function degree of constant relative risk aversion (=2) initial wealth (=2664 euro per ha) Farmer’s welfare is computed as certainty equivalent of profit

OECD Trade & Agriculture Directorate 10 Incentive to use risk market strategy: Crop yield insurance Proportion of planted area insured

OECD Trade & Agriculture Directorate 11 Risk and welfare impact of risk market strategy: Crop yield insurance

OECD Trade & Agriculture Directorate 12 Comparison of policy impacts Impacts of 2 euro expected subsidy through different instruments * Cost of insurance and forward contracting are assumed as 10% and 5%, respectively. Certainty equivalent profit (change in euro) CV of profit (change in percentage points) Overall change Contributing factors Change in mean Change in variability Single farm payment Subsidy to crop yield insurance premium Subsidy to forward price

OECD Trade & Agriculture Directorate 13 Interaction between single farm payment and crop yield insurance strategy * Insurance price premium is assumed to be 3%. Proportion of planted area insured

OECD Trade & Agriculture Directorate 14 Some preliminary findings  Farmer faces higher yield variability, and lower negative yield-price correlation than it looks at the aggregated data  Farmer is making use of correlations and crop diversification to stabilize income  Participation to risk markets is difficult even for relatively low administrative costs  Interaction between government programme and risk management strategy (e.g., impacts on crop diversification and crowding out of risk market instruments)

OECD Trade & Agriculture Directorate 15 Thank You Trade and Agriculture Directorate Visit OECD’s risk management project website: Contact us: