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Futures Prices in Supply Analysis: Are Instrumental Variables Necessary?
Author(s) -
Hendricks Nathan P.,
Janzen Joseph P.,
Smith Aaron
Publication year - 2015
Publication title -
american journal of agricultural economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.949
H-Index - 111
eISSN - 1467-8276
pISSN - 0002-9092
DOI - 10.1093/ajae/aau062
Subject(s) - futures contract , predictability , economics , instrumental variable , econometrics , yield (engineering) , convenience yield , shock (circulatory) , price elasticity of supply , variable (mathematics) , agricultural economics , price elasticity of demand , financial economics , spot contract , statistics , microeconomics , mathematics , medicine , materials science , metallurgy , mathematical analysis
Abstract Crop yield shocks are partially predictable—high planting‐time futures prices have tended to indicate that yield would be below trend. As a result, regressions of total caloric production on futures prices produce estimates of the supply elasticity that are biased downwards by up to 75%. Regressions of the world's growing area on futures prices have a much smaller bias of about 20% because although yield shocks are partially predictable, this predictability has a relatively small effect on land allocation. We argue that the preferred method for estimating the crop supply elasticity is to use regressions of growing area on futures prices and to include the realized yield shock as a control variable. An alternative method for bias reduction is to use instrumental variables (IVs). We show that the marginal contribution of an IV to bias reduction is small—IVs are not necessary for futures prices in supply analysis.