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Free Content Can rent adjustment clauses reduce the income risk of farms?

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Risk management is gaining importance in agriculture. In addition to traditional instruments, new risk management instruments are increasingly being proposed. These proposals include the rent adjustment clauses (RACs), which seem to be an unusual instrument at first sight. In contrast with conventional instruments, RACs intentionally allow fixed-cost ‘rent payments’ to fluctuate. We investigate the whole-farm risk reduction potential of different types of RACs via a historical simulation. The change in standard deviation and the value at risk (VaR) of the total gross margin (TGM) measure risk reduction potential. Our results revealed that RACs contribute to farm risk management. However, the trade-off between moral hazard and basis risk must be considered. Our proposal of weather index-based RAC seems to be a ‘good compromise’: the problem of moral hazard is completely eliminated by objectively measuring weather data. At the same time, the risk reduction potential of precipitation-based clauses, for example, is comparatively high.

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Keywords: Risk management; basis risk; moral hazard; rent adjustment clause; value at risk; weather index

Document Type: Research Article

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Publication date: July 1, 2012

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