Farmers' Use of Forward Contracting and Hedging

Logit models of farmers''forwardpricingpractices are developed. Results indicate: (a) farm size significantly affects use of hedging and forward contracting, (b) farmers' inclination to search for information is related to their forward pricing practices, and (c) forward pricing practices are complementary with other risk-reduction methods. Introduction The demand for most U.S. agricultural products is inelastic, producing unstable farm gate prices. Due to weather-related supply uncertainties, policy-induced shifts in supply, and abrupt changes in the global demand for U.S. exports, price volatility has become common for many cash crops, especially grains and oilseeds. Clearly, agricultural producers have an incentive to seek some means of reducing the profit uncertainty caused by price instability. Forward contracting and hedging are among the tools available for this purpose. This study investigates farmers' use of forward contracting and hedging. Producer benefits from forward contracting and hedging are well documented. The farmer who invests capital to acquire inputs without selling or establishing the product price is speculating and bears substantial risk (Paul et al. [1985]). The use of forward pricing strategies can help reduce price risk in volatile commodity markets and stabilize farm income (Zacharias et al. [1987]; Tomek [1987]; Paul et al. [1985]). Much of the past research on farmers' use of hedging and forward contracting has emphasized their use in the context of risk reduction using portfolio concepts (Peck [1975]; Heifner [1973,1978]; Harwood and Tomek [1987]; Barry and Willmann [1976]; Miller [1986]; Zacharias et al. [1987]). Tomek states that empirical applications of the portfolio approach "suggest that the optimal futures position is often a large percent—say 75 to 100—of the expected cash position" (Tomek [1987] p. 7). Studies that incorporate yield risk into their analysis report optimal hedging proportions ranging from 20 to 60 percent for soybeans and 60 to 70 percent for corn (Alexander et al. [1986]; Grant [1988]). Given these risk-reduction advantages, widespread adoption of hedging and/or forward contracting would be expected. However, farmers consistently use these marketing tools less than portfolio studies suggest they should. A 1972 survey of Kansas grain farmers indicated that just 4 percent of the respondents ever had hedged a portion of their crop and only 12 percent had engaged in some forward contracting (Hill [1972]). The same survey was repeated in 1983, and the percentages had increased slightly to 7 percent ever having used hedging and 18 percent having used forward contracting (Tierney [n.d.]). Helmuth reports similar rates of use at the national level. Approximately 12 percent of the grain farmers used futures markets for both hedging and speculation in the 1972-76 period, and only 17 percent reported the use of forward contracting. Leath [1986] reports that about 19 percent of Midwestern and Southern soybean producers used any forward contracting in 1982-83, a period of extremely large price volatility. As a final example of the relative small use of these marketing tools, Tierney estimates that less than 5 percent of Midwestern farmers used hedging and less than 15 percent used forward contracting in