Portfolios of Agricultural Market Advisory Services: How Much Diversification Is Enough? (Report 2003-02)

AgMAS Project Office, Department of Agricultural and Consumer Economics, (217) 333-2792, agmas@uiuc.edu

Agricultural market advisory services offer specific advice to farmers on how to market their commodities. Farmers can subscribe to one or more of these services and follow their advice as a way of managing price risk. According to portfolio theory, a combination of these services may have risk/return benefits compared to individual services.

This report analyzes the potential risk reduction gains from naïve diversification among market advisory services for corn and soybeans. Results show that increasing the number of (equal-weighting) services reduces portfolio expected risk, but the marginal decrease in risk from adding a new service decreases rapidly with portfolio size. The risk reduction benefits of naïve diversification among advisory services is relatively small compared to the results obtained in previous studies for stock portfolios, and this is mainly because advisory prices, on average, are highly correlated. One service portfolio has only a 20%, 16% and 32% higher expected standard deviation than the minimum risk naïve portfolio for corn, soybeans and 50/50 revenue, respectively.

Most risk reduction benefits are achieved with small portfolios. For instance, a four service portfolio has only 5%, 4% and 9% higher expected standard deviation than the minimum risk naïve portfolio for corn, soybeans and 50/50 revenue, respectively. Based on these results, there does not appear to be strong justification for farmers adopting portfolios with a large number of advisory services. Farmers may well choose portfolios with as few as two or three programs, since the relatively high total subscription costs associated with larger portfolios can be avoided while obtaining most of the benefits from diversification. More information can be found at http://www.farmdoc.uiuc.edu/agmas/reports/index.html.