The role of financial engineering in agriculture


For much of the public, financial engineering was the main culprit in the recent financial collapse shown in popular movies that include The Big Short or Margin Call.  Financial engineers essentially were shown to create new derivative products that allowed investment banks to take on excessive risk that eventually brought down the U.S. Economy.

However, financial engineering has a much different relationship in agriculture.  For example, crop insurance is the main risk management tool used by farmers to avoid adverse price and yield risk.  Crop insurance is a derivative product that allows farmers to transfer their risk to insurance companies.  It is also a simple example of how financially engineered products can be developed to reduce risk for those interested in reducing risk exposure.  Furthermore, if we consider the Harvest Price Option included in most Revenue Protection insurance products, the usage of financially engineered products is already more widespread that you might think.Over the last few years, financial engineering has led to the growth in more customizable products that allow producers to customize the risk they want to take on.  For example, the Cargill Ultra Pacer Ultra product allows producers to lock in a price floor while taking advantage of positive price movements.  This product comes from the basic idea that not all risk is bad.  High prices are great for producers.  While this product is not free, it is also not a trick being played by Cargill.  Like any other buyer of grain, they want to provide incentives for producers to sell to them and find it beneficial to offer more products that might entice more customers.  Cargill is not the only company that have tried to expand their marketing portfolio through financial engineering in order to retain customers.  Other examples include CHS, CGB, and a growing list of others.  Many of these financially engineered products are offered in the Midwest, main due to the liquidity of corn and soybean futures and options markets.  However, these products are making their way into Montana grain contracts.

Last year the first two graduates from the MSU Financial Engineering program graduated.  This program is a joint program between the College of Engineering and the Department of Agricultural Economics and Economics.  It is anticipated to grow quickly over the next few years.  Upon graduation, these students will be able to develop new agricultural marketing products, run stress tests on banks, assess overall risk across a portfolio of products, among other things.  In the future, these graduates will be on the front lines in developing new and exciting products offered in banking and agricultural insurance.

For additional information, Dr. Joe Atwood presented our research related to financial engineering this last week at the 2016 Agricultural and Applied Economics Association conference in Boston, MA.


About Author

Eric Belasco is an Associate Professor in the Department of Agricultural Economics and Economics at Montana State University. He received both his M.S. and Ph.D. in Economics from North Carolina State University in 2005 and 2007, respectively. He conducts research in the areas of agricultural marketing, risk management, farm policy, and financial engineering. Examples of this research include evaluations into grid pricing risk, the use of forward contracts in mitigating profit risk, modeling revenue risk in cattle production, and characterizing the link between weather and production indicators.

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