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Quantification of the risk associated with the seasonal financing of agricultural production : a thesis presented in partial fulfilment of the requirements for the degree of Master of Agricultural Economics, Massey University
Since the abolition of government support policies for both agricultural and financial industries during the early 1980s, participants have had to take direct responsibility for the management of the risks involved in their business activity. As a prerequisite to the development of practical risk management strategies and techniques, quantification of risk is considered by this thesis.
A quantification risk index that incorporates both the third and fourth moments of a distribution, thus adding to variance and monotonic transformations, the traditional surrogate risk measures, was developed and applied to sheep and beef farming.
The risk index is developed using logit analysis, where risk is directly estimated. Logit analysis was used because it suited the thesis definition of risk. In this thesis, risk is defined as the probability of incurring loss or harm, where loss or harm is defined, in the context of sheep and beef farming, as zero or less than zero 'net cash returns'. Net cash returns are defined as all cash revenues generated by farm production less all farm and farmer expenditures. The index, or probability, is directly estimated given forecast average market prices, effective farm area, total farmer forecast expenditures and island location (North or south).
The risk index has been developed for banker application to farm budgets submitted for the purposes of seasonal finance approval. The banker is warned by the index that the proposed farm plan has a high probability of ending in farm insolvency and an inability of the farmer to service all lending in the forthcoming year, solely from farm production.
As a consequence of applying the measure to sheep and beef farming, the thesis found that in terms of risk to net cash returns, effective farm area in conjunction with total farmer expenditure is significantly ranked higher than fluctuating market product prices, and that risk trade-offs exist between farm area and expenditures. In a situation of small farm size with relatively high expenditures, optimistic product prices are insufficient to offset the high probability of incurring negative net cash returns.
