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MATHEMATICAL PROGRAMMING FOR RISK MANAGEMENT IN AGRICULTURE. Garth A. Baker Director of Research, Caribbean Institute for the Mathematical Sciences “ Nothing is more practical than a good theory” -- Descartes. PARTICIPATING INSTITUTIONS ( March 8. 2004 )
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Garth A. Baker
Director of Research,
Caribbean Institute for the Mathematical Sciences
“ Nothing is more practical than a good theory” -- Descartes
Dominica Banana Producers Limited ( DBPL )
Nature Island Pineapple Producers Association ( NIPPA )
Caribbean Agricultural Research and Development Institute (CARDI)
Caribbean Institute for the Mathematical Sciences ( CIMS )
OECS Export Development Unit ( OECS-EDU )
Dominica Export Import Agency ( DEXIA )
Windward Islands Crop Insurance Limited ( WINCROP )
Centre de Cooperation Internationale en Recherche Agronomique pour le Development ( CIRAD ), Paris, France
EMPLOY SCIENTIFIC RESEARCH TO PILOT BUSINESS INITIATIVES
IN THE FORM OF JOINT VENTURESDOMINICA QUANT–CONSORTIUM ON AGRICULTURE
Revive the banana industry
OPTIMIZATION OF PRODUCTION
qWhat does the market want?
qOrganize production to fit the market. Take the “guesswork” out of production
qUse accurate, scientific crop forecasting
qAffordable catastrophe insurance. Can fine structure
modeling for the Caribbean improve catastrophe
qHedge market risk with financial instruments. Take the
“uncertainty” out of export marketing.
qAffordable insurance for crops other than bananas.
coverage for drought, flood and possibly disease.
qLower production costs.
qAcquire greater market share.
qDistinguish Caribbean product; aim for
qOptimal transportation networks: dynamic
Pliny the elder
“ Common sense is not so common.”
“ A fool must now and then be right by chance.”
qAlternative Risk Transfer
Securitization of Agricultural Insurance Risk
Fixed income securities / Hedge Funds
“ Most business and financial transactions are “ a gamble “ wherein the buyer hopes to be buying low, and the seller hopes to be selling high. One side is always doomed to disappointment.” Peter Bernstein, economic consultant, 1996.
“Every act of production is a speculation in the relative value of money and the good produced.” Frank Knight, economist, 1977.
Farmers stand to benefit from high sale prices and are vulnerable to low sale prices; in symmetric contrast, supermarkets/ processors tend to benefit from low sale prices and high sale prices are threatening to them.
II.Each supermarket/processor pays the bank a premium, say 5 Arawak, for the right to buy the produce (through or from the bank) at the prearranged price of 100 Arawak, during the period up to January 1. The supermarket/processor has the option to exercise this right to buy at the specified price or not, during the period of validity of the contract, and should the supermarket/processor opt to buy at any such time, the bank is legally bound to effect the sale.
their premium, but in effect pays 70 + 5
= 75, thus making a profit of 25.
effect sell at 122 – 3 = 119, yielding a
profit of 19.
Fischer Black -----Arthur D. Little
Myron Scholes ----M.I.T. 1973
Robert Merton ----M.I.T.
time,interest rates,price spread,volatility
1997 Nobel Prize in Economics
Louis Bachelier , These, Universite Paris, 1900
Chicago Board Options Exchange, April 1973
A B C ● ● ● X Y Z
Securities Exchange ( OECS/ CARICOM )
What types of contracts are best suited for hedging market risk in agriculture (volatility) to protect OECS producer – marketing – processing chain ? How are these contracts to be managed and overseen, with transparency and international legal credibility?
Diversification should be pursued based upon optimization critera, taking into account both market information and agro-ecological conditions and economic and social constraints. i.e. “ market driven optimization of production”: however, what is to be optimized is the performance of the portfolio as a whole over time. The relevant question is: What (diverse) combination of crops yields optimality? Value at Risk type analysis.
Lecture at the University of Utha, November 1994
“ There are some who would argue that the role of the bank supervisor is to minimize or even eliminate bank failure; but this view is mistaken in my judgment. The willingnessto take risk is essential to the growth of a free market economy . . . [I]f all savers and their financial intermediaries invested only in risk-free assets, the potential for business growth would never be realized.”
CAESAR: He is a dreamer; let us leave him –
Act I, Scene II
Sweet are the uses of adversity;
Which, like the toad, ugly and venomous,
Wears yet a precious jewel in his head;
As You Like It
Act II, Scene I.