VALUING COUNTER-CYCLICAL PAYMENTS: IMPLICATIONS FOR PRODUCER RISK MANAGEMENT AND PROGRAM ADMINISTRATION

USDA’s current method for estimating expected counter-cyclical payment rates produces unintentionally biased estimates because it does not consider the variability of marketing year prices. Estimates with positive bias increase the risk of overpayment to producers who accept advance payments. According to statute, producers must reimburse the Government for any overpayments, which can lead to cash-flow problems. A model developed for this analysis improved upon the USDA method of estimating counter-cyclical payment rates by accounting for the variability in market price forecast errors. This enhanced method produced unbiased estimates. Forecasters and producers can also use the model to calculate the probabilities of repayment. Producers can use call options on commodity futures contracts to hedge against losses in expected counter-cyclical payments. Hedging, however, is only moderately effective and varies by commodity.