Risk Management Instruments Research Articles

Financing Food Assistance: Options for the World Food Programme to Save Lives and Dollars

The World Food Programme has world-class logistics, but its ability to manage financial risk is extremely limited. The WFP procures 100 percent of its food through spot markets, which subjects it to substantial commodity and transport price risks and significant delays delivering food. Relying on reactive emergency appeals and on donors that tend to earmark contributions and make commitments one year at a time only adds to operational inflexibility and uncertainty. On the other hand, much of the WFP’s operations are fairly predictable, especially the countries served and the volume of food delivered. The Programme should consider implementing a targeted hedging pilot strategy focused on several chronically food vulnerable countries. Several risk-management instruments are available, such as physical call options, forward contracts, and futures contracts. Key benefits of such hedging strategies would include greater financial predictability, the potential for improved delivery times, and increased local and regional trade that could build on the WFP’s Purchase for Progress initiative. Changes from donors would also help the WFP shore up its operations. Greater commitments of untied cash donations from the United States and other major donors can provide the WFP significant operational flexibility to execute prudent financial management operations. Donor contributions to the proposed Food Security Trust Fund at the World Bank would further support WFP hedging operations. This fund could provide a financial guarantee or modest credit line which would enable the WFP to enter into commodity derivative contracts for up to one year in the future.

An empirical analysis of supply chain risk management in the German automotive industry

The purpose of this paper is the empirical analysis of supply chain risk management practices. The analysis is based on a survey with 67 manufacturing plants conducted in the German automotive industry. After investigating the vulnerability of supply chains in general and examining key drivers of supply chain risks, the paper identifies supply chain risks by analyzing their likelihood to occur and their potential impact on the supply chain. The results are visualized in the probability-impact-matrix distinguishing between internal and external supply chain risks. Furthermore, instruments for dealing with supply chain risks are investigated. Therefore, the impact of supply chain risk management on performance is tested. In order to distinguish between companies with a high degree of supply chain risk management and those with no or only limited implementation the plants are grouped by means of a cluster analysis based on factors reflecting the instruments of supply chain risk management. In particular, groups are created representing two different approaches to deal with supply chain risks, i.e. reactive and preventive supply chain risk management. The clusters are investigated concerning differences in terms of performance criteria. The analyses reveal that companies with a high implementation degree show a better supply chain performance. Furthermore, the results show that the group using reactive supply chain risk management has higher average value in terms of disruptions resilience or the reduction of the bullwhip effect, whereas the group pursuing preventive supply chain risk management has better values concerning flexibility or safety stocks.

Design considerations for financing a national trust to advance the deployment of geologic CO 2 storage and motivate best practices

This paper explores how the widely held public policy view of the evolution of the risk profile associated with geologic carbon dioxide (CO 2) storage profoundly influences the public policy dialogue about how to best address the long-term risk profile for geologic storage. Evidence emerging from research and pilot scale field demonstrations of CO 2 storage demonstrates that, with proper site characterization and sound operating practices, retention of stored CO 2 will increase with time thus invalidating the premise of an ever growing risk. The authors focus on key issues of fit, interplay, and scalability associated with the ability of a trust fund funded by a hypothetical $1 per tonCO 2 tipping fee for each ton of CO 2 stored in the United States under WRE450 and WRE550 climate policies to manage such risks in an economically efficient and environmentally effective manner. The authors conclude there is no intrinsic value – in terms of risk management or risk reduction – in creating a trust fund predicated solely on collecting a universally applied tipping fee that does not take into account site-specific risk profiles. If left to grow unchecked, a trust fund that is predicated on a constant stream of payments unrelated to each contributing site's risk profile could result in the accumulation of hundreds of billions to more than a trillion dollars contributing to significant opportunity cost of capital. Further, rather than mitigating the financial consequences of long-term CCS risks, this analysis suggests a blanket $1 per tonCO 2 tipping fee, if combined with a concomitant limitation of liability may increase the probability and frequency of long-term risk by eliminating financial incentives for sound operating behavior and site selection criteria—contribute to moral hazard. At a minimum, effective use of a trust fund requires: (1) strong oversight regarding site selection and fund management, and (2) a clear process by which the fund is periodically valued and funds collected are mapped to the risk profile of the pool of covered CCS sites. Without appropriate checks and balances, there is no a priori reason to believe that the amount of funds held in trust will map to the actual amount of funds needed to address long-term care expenses and delimited compensatory damages. For this reason, the authors conclude that financing a trust fund or other risk management instrument should be based on a site delimited estimate of potential future expected financial consequences rather than on the random adoption of a fixed funding stream, e.g., a blanket $1 per ton, because it “sounds” reasonable.

Management of climate risks in agriculture–will weather derivatives permeate?

It is a matter of common knowledge that weather represents the major source of uncertainty in crop production. It is to be expected that weather fluctuations will increase in the future due to climate change. Traditionally, farmers tried to protect themselves against weather-related yield variations by buying insurances. More recently, there has been a discussion regarding the use of weather derivatives to safeguard against volumetric risks. Although weather derivatives display advantages over traditional insurances, there is only a relatively small market for these products in agriculture. This is partly attributed to the fact that it is unclear whether and to what extent weather derivatives are a useful instrument of risk management in agriculture. This study applies real yield and weather data from Northeast Germany in order to quantify the risk-reducing effect that can be achieved in wheat production by using precipitation options. To do so stochastic simulation is used. The hedging effectiveness is controlled by the contract design (index, strike level, tick size). However, the local basis risk and the geographical basis risk remain with the farmer. We separate both causes of basis risk and reveal the extent of each. This enables conclusions regarding the design of weather derivatives; thus the question dealt with here is relevant both for farmers and for potential sellers of weather derivatives.

The role of subsidies in managing the operating risk of agricultural enterprises

The paper examines the relationship between the farmers’ operating risk and current subsidies. Focused at the commodity level, the analysis is based on a sample survey of costs and yields of two crops (winter wheat and rapeseed) and two livestock commodities (cow milk and fattening cattle) carried out in 2005–2007 in the Czech Republic. The risk analysis relates to the growing conditions, crop yields and the livestock productivity. The future role of the subsidies as the risk management tool in the farming business, as well as the position of this instrument against the other risk management instruments is analysed. The break even analysis and the Monte Carlo simulation are used as analytical tools. The results indicate that the current subsidies have an impact on the stability of the farmers’ income. Partially or fully decoupled payments serve as a “financial pillow” increasing the level of the farmers’ income and extending the farmers’ decision-making possibilities. Furthermore, the current subsidies reduce the variability of the farmers’ income. The current subsidies are a suitable complement to other commonly used risk management tools primarily designed to reduce the farmers’ and farm income variability.

Development institutions: Analysis and assessment of world practices

Development institutions’ practices in various countries are analyzed. A classification of development institutions by type, objective, and risk management instruments is suggested. Preliminary conclusions concerning the optimal structure of development institutions for the Russian economy are made.

Is geographic diversification sufficient to limit contract grower risk?

Lending and financial institutions have looked for a variety of ways to expand their portfolios into agriculture, but because of the risks associated with lending to farmers who lack traditional forms of collateral, they face price and yield risks, causing these inroads to be limited. Market-based instruments are readily available for price risk. Organised exchanges offering the most basic of these instruments, futures and options, have operated for a long time, providing transparency to the market and low-cost risk transfer tools for those able to access them. While the use of price risk management instruments is an incomplete solution, it has sufficient merits on its own and will make the overall burden of risk more bearable. The use of these instruments and multi-peril crop insurance products is expensive and does not provide full protection for financial lending institutions to limit their credit risk exposure. This article determines whether geographic diversification would be sufficient as a risk management tool for lending institutions to limit their credit risk.

Does Risk Management Matter? Evidence from the U.S. Agricultural Industry

This article constructs triple-difference tests around shifts in the supply of risk management instruments available to agricultural producers to reveal a positive relation between risk management and productivity. This relation is more robust when producers adopt instruments with payoffs linked to group performance and weaker when payoffs are linked to individual performance. Additionally, productivity is particularly high among risk-managing producers in counties containing high levels of bank deposits, a proxy for access to finance. Overall, this article illuminates the relation between hedging and real firm outcomes as well as the interaction between access to finance and firms’ risk management choices.

Spatial‐Temporal Model of Insect Growth, Diffusion and Derivative Pricing

AbstractInsect derivatives represent an important innovation in specialty crop risk management. An active over‐the‐counter market in insect derivatives will require a transparent pricing method. This paper develops an econometric model of the spatio‐temporal process underlying a particular insect population and develops a pricing model based on this process. We show that insect derivatives can play an important risk management role in mitigating B. tabaci (whitefly) damage in cotton. Beyond developing a new risk management instrument, the key methodological contribution of this paper lies in pricing derivatives with stochastic properties in both space and time dimensions.

Risk management instruments for debt driven conservation efforts: The case of India's Project Tiger

Project Tiger has been India's premier case of conservation success. Since mid 1990s select Project Tiger Reserves in India were chosen for intensive funding by the Global Environment Facility, the International Development Agency (IDA) and the Government of India under the ‘India Eco-Development Project’. This project marked a modest shift towards debt based funding. The GEF Project has become a benchmark for tiger conservation in India both in terms of management outcomes and scale and scope of funding. However in the absence of large-scale budgetary support or self-generating income flows, it becomes difficult for the GEF type of project to be replicated in other tiger reserves of the country. Debt instruments hold promise as enablers of conservation finance. The paper proposes issue of ‘tiger bonds’ to meet the financial requirements of tiger reserves. Though attractive as a debt instrument, a ‘tiger bond’ could nevertheless entail interest rate and default risks. Bioprospecting activities form good revenue sources for tiger reserves to pay off their debts. However bioprospecting activities do not provide assured returns to tiger reserves. Pharmaceutical companies that prospect for genetic resources and practice ‘real options’ approach to R&D investment planning, adopt multi-phased investment systems and sequential searches that gives them the flexibility to abandon R&D projects. From the point of view of genetic resource providing entities like Project Tiger Reserves, the ‘postponement value’ generated by real options, enables a drug company to tap substitutes for the genetic resources that form the subject matter of bioprospecting contracts. To obviate possible repayment risks by tiger reserves, the paper advocates the institution of ‘put bonds’ as a risk management tool for Project Tiger Reserves in order to hedge themselves against loan defaults arising from possible loss in bioprospecting income. The paper also brings out the mechanics of the issue of tiger bonds in the Indian context. It is argued that a put bond not only hedges default risks but would also aid ‘value discovery’ and payment for ecosystem services as far as the Project Tiger Reserves of India are concerned.

A Hybrid System-Econometric Model for Electricity Spot Prices: Considering Spike Sensitivity to Forced Outage Distributions

With the current trend in deregulation, all electricity markets have been subject to volatile electricity prices, typically in peak season. As markets mature, new financial and operational risk management instruments are becoming available. In order to price such instruments, a model for the underlying price process is required. In this paper a hybrid model is described that contains aspects of the power system, as well as the historical time-series of spot prices observed in the market. By including both aspects of the problem, a model with both economic and system-based aspects is created. Its modular design allows easy adaptation to different markets based on generating system reliability, load patterns, and price histories. The spot price histories are manifest in two probability distributions for these prices, whereas the system specifics are included via load and generation models which are calibrated to the climate and system of interest.

The Underinvestment Problem, Risk Management, and Corporate Earnings Retention

This study presents a very realistic objective of the firm, which is consistent with organizational behavior. It is being proposed that: The firm sets as its objective the control of the optimum amount of financial capital at the minimum cost to the firm. As evidenced by the large portfolios of marketable equity securities held by non-financial firms, the firm hoards financial capital in order to ensure future availability. There is a holding or storage cost; that is, in pursuing this objective, the firm incurs (pays) a premium to ensure control over an attained level of financial capital. This study maintains that this cost is tantamount to a premium as in the case of an insurance policy. Thus, corporate earnings retention is a case of optimization under uncertainty and dividend policy is viewed as an instrument of risk management. This objective, which addresses the underinvestment problem, fills the gap on what the firm should maximize and provides an alternative to the debatable maximization of shareholders' wealth.

Trends in the study of genetic susceptibility

Genotoxicology investigates the molecular basis of cellular responses to DNA damage. During more than three decades of genetic toxicology testing, a large number of tests with varying sensitivity and specificity have been developed. These genotoxicity tests can predict: the likelihood of a substance to be a (rodent) carcinogen, the mechanism of carcinogenic activity of different substances, if the results of genotoxicity studies only predict carcinogenicity or they are a distinct hazard endpoint (Nohynek, 2005). The current genetic toxicity testing batteries represent: Ames test which is a component of all genetic testing batteries. A mammalian cell mutagenicity assay which should confirm or complete the Ames test. Chromosomal aberrations tests which are based on a different endpoint than gene mutations. Positive in vitro results need to be confirmed by in vivo tests; results from test batteries have higher predictive value than results of a single test (Nohynek, 2005). The human molecular epidemiology represents a new trend in the study of genetic susceptibility and interactions between genetic and environmental factors of risk. Doses and biochemical effects biomonitoring have nowadays a tremendous utility providing an efficient means of measuring human exposure to chemical substances. Human biomonitoring considers all routes of uptake and all sources which are relevant making it an ideal instrument for risk assessment and risk management; blood is by far the most approved matrice. Human biomonitoring can be done for most chemical substances which are in the focus of the worldwide discussion of environmental medicine (Angerer et al., 2007). Molecular epidemiology studies of human populations exposed to potential mutagens have the aim to assess the risk of genetic disease or cancer by analysing the relationship between internal exposure and biological effects in target cells under consideration of confounding factors (Faust et al., 2004). Human biomonitoring can identify new chemical exposures, trends and changes in exposure, establish distribution of exposure among the general population, identify vulnerable groups and populations with higher exposures and identify environmental risks at specific contaminated sites. The sensitivity of methods moreover enables the elucidation of human metabolism and toxic mechanisms of the pollutants (Angerer et al., 2007). Biomarkers of effect that indicate exposure to a causative agent and that reflect the individual risk of disease are numerous. The most commonly used biomarkers in cancer epidemiology include: measurements of DNA damage, such as DNA breaks, altered bases, bulky adducts; chromosomal aberrations (CA), micronuclei (MN) and sister chromatid exchange (SCE), which are also the results of DNA damage (Kassie et al., 2000; Collins, 1998). Chromosomal aberrations and micronuclei are biomarkers of damage due to genetic instability or exposure to environmental mutagens or carcinogens. A recent approach is to associate the biomarkers of genetic susceptibility which take into account cancer susceptibility and interindividual differences in the response to a genotoxic exposure, and the analysis of CA and/or MN, which serves as a biomarker of interactions between the environment and the genetic material of the cell. Information is being gathered on how DNA damage and more particularly the frequency of chromosomal aberrations and/or micronuclei depend on the polymorphisms in genes implicated in xenobiotic metabolism (activation and/or detoxification) and DNA lesion repair. For biomonitoring purposes, numerous confounding factors (age, sex, tobacco consumption, etc.) influence the CA and MN biomarker, and thus associating genetic polymorphisms to CA and MN would be useful to better define the prevention and prediction of risk (Iarmarcovai et al., 2007a; Iarmarcovai et al., 2007b). The in vitro genetic toxicology tests used for regulatory purposes measure formation of gene mutations and chromosomal changes following DNA damage induced by the compounds under test, and are used to predict the carcinogenic potential of pharmaceuticals, industrial chemicals, food additives and cosmetic ingredients (Kirkland et al., 2007). In vitro test systems will aid in the identification of the most sensitive species and strains. Also, in vitro systems are good models for studying qualitative and quantitative species differences in toxicity. Further, in vitro systems are excellent models for characterisation of the mode of action/mechanism for critical effects, but findings need to be validated in vivo. In vitro systems will aid in the extrapolation from high to low dose and from experimental animals to humans (Holme et al., 2002).

Producers' complex risk management choices

AbstractProducers have a wide variety of risk management instruments available, making their choice(s) complex. The way producers deal with this complexity can vary and may influence the impact that the determinants, such as risk aversion, have on their choices. A recently developed choice bracketing framework recognizes that producers are unable to evaluate all alternatives simultaneously and that to manage a complex task, they often group or bracket individual alternatives and their consequences together in choice sets. Data on 1,105 U.S. producers show that producers do not use all available combinations of risk management tools and that the influence of the determinants of producer's risk management decisions are not necessarily the same across risk management strategies within and across bracketing levels. The findings may help resolve puzzling results on the role that well‐known determinants of risk management behavior have on producers' choices, extending knowledge on producers' risk management behavior. Further, the findings have managerial implications for policy makers and agribusiness companies that provide risk management services. [EconLit citations: M000, G1000, Q130] © 2008 Wiley‐Liss, Inc.

Corporate risk-management practices in Slovenian companies

The paper presents the original research results on the corporate risk-management practices in the large Slovenian non-financial companies. The implementation of different risk-management strategies and the use of risk-management instruments are thoroughly investigated, primarily through a survey of risk-management practitioners. The survey has revealed that the vast majority of analysed companies are using some form of interest rate, foreign exchange or commodity price risk-management and those companies are highly influenced by the price risk, whilst currently and interest-rate risk exposures have lower impact on their performance. Companies quite often do not have documented their policies and often are just following the flow and practice fashion.

Outsourcing contracts as instruments of risk management

PurposeThis paper aims to examine contracts in public jurisdictions to compare academic theories related to outsourcing risks and risk management strategies to current practice in order to extend and refine theory concerning what risk management strategies can, or should, be included in outsourcing contracts.Design/methodology/approachAn automated content analysis tool is used to rigorously compare contract documents in two public jurisdictions to a comprehensive outsourcing risk framework from previous research.FindingsThe findings indicate that although IS outsourcing risk factors are widely acknowledged in the literature, they are not fully specified in the outsourcing contracts that are implemented in some public organizations. This research surfaces some of the differences in the techniques implemented through actual contracts to manage the risks inherent in IS outsourcing, including some strategies not previously identified in the literature. Also, not all risks need to be addressed in the contract to have a successful outsourcing engagement.Practical implicationsThe improved framework for thinking about risk management strategies in the contracting process shown within the paper can provide important ideas and insights for managers contemplating or renewing outsourcing engagements.Originality/valueThis paper uses content analysis to rigorously compare academic theory to actual practice to extend theory. Specifically, it discovers several risk management strategies that have not been presented in previous research.

The German minimization concept for acrylamide

The German minimization concept for acrylamide was established as a reaction to the concern caused by the discovery of acrylamide in a wide range of foodstuffs in 2002. It is a pragmatic approach based on a voluntary agreement of all partners involved, governmental organizations as well as the affected industry, with the common aim of a gradual reduction of acrylamide contents in food. Now, about four years after its initiation, an evaluation has shown the potential of this concept. For some commodity groups, minimization of acrylamide contents has already been successful, while further minimization efforts are necessary in other groups to achieve a comprehensive minimization in all food groups concerned. In contrast to legal regulations, the minimization concept is a soft risk management instrument. It represents a novel approach, for instance to cope with situations when maximum levels are not available. Such a concept can be considered as a smart solution to bring about preventive measures resulting in health protection. As an innovative risk management tool, it has the potential to tackle the challenges of consumer protection in the future.

The Unbiasedness and Hedging Effectiveness in KOSPI200 Futures Market

This study is to examine the unblasedness hypothesis and hedging effectiveness in KOSPI20() futures market. The unbiasedness and efficiency hypothesis is carried out using a cointegration methodology. And hedging effectiveness is measured by comparing hedging performance of the naive hedge model, OLS hedge model. and constant correlation bivariate GARCH (1. 1) hedge model based on rolling windows. The sample period covers from May. 3. 1996 to December. 8, 2005. The empirical results are summarized as follows: First, there exists the cOintegrating relationship between realized spot prices and futures prices of the 10 day. 22 day. 44 day. and 59 day prior to maturity. Second. futures prices of backward the 10 day. 22 day. 44 day from maturity provide unbiased forecasts of the realized spot prices. The KOSPI200 futures price is likely to predict accurately future KOSPI200 spot prices without the trader having to pay a risk premium for the privilege of trading the contract. Third. for shorter maturity. the futures price appears to be the best forecaster of spot price. Forth, bivariate GARCH hedging effectiveness outperforms the naive and OLS hedging effectiveness. The implications of these findings show that KOSPI200 futures market behaves as unbiased predictor of future spot price and risk management instrument of KOSPI200 spot portfolio.

Zwei Jahre RIMAX—Rückblick und Ausblick

To develop and implement improved instruments for flood risk management in Germany, the national research programme ‘Risk management of extreme flood events’ (RIMAX), funded by the German Federal Ministry of Education and Research (BMBF), was initiated. More than 30 joint projects are in progress under this framework since January 2005. An extended brochure which provides information regarding all projects currently funded by the RIMAX research programme is available from the RIMAX-website (www.rimax-hoch wasser.de). Intensive research has been carried out during the first two years of the funding initiative and several workshops were held to enhance the scientific discussion and the communication between the numerous projects. To develop communication pathways between research and practice RIMAX was presented at the ‘acqua alta 2006’, a trade fair for flood prevention and disaster management. Furthermore, a working group from the German Association for Water, Wastewater and Waste (DWA) is in the process of forming which aims at supporting the transfer of research results into practice. In 2006, five additional projects commenced. However, most of the projects funded in 2005 concentrate on the completion of their research and publishing their findings. A RIMAX-wide concept for the documentation and presentation of the results is currently developed by the coordinating team. More information and current news are available from the RIMAX-website (www.rimax-hochwasser.de).

Finding optimal price risk management instruments: the case of the Spanish potato sector

AbstractThis article offers a comprehensive analysis of the problem of choosing between alternative market risk management instruments. We model farmers' behavior to optimize the certainty equivalent, formulated by a mean–variance model, by combining instruments with and without basis risk. Results are expressed as the demands for hedging with futures, forward contracts and insurance. Theoretical results are applied to a selection of Spanish producers of fresh potatoes, a sector that is exposed to significant market risks. Amsterdam's Euronext provides potato futures prices, and the recently launched revenue insurance in Spain provides the example for price insurance. Three conclusions summarize the article's main findings. First, we show that Spanish potato revenue insurance subsidies are a factor that determines the instrument rankings and choice. Second, the efficiency of insurance subsidies is generally low. Finally, the Amsterdam potato futures market does not provide a cost‐effective means to manage price risks for Spanish fresh potato growers.