Agricultural Arbitrage, Adjustment Costs, and the Intensive Margin

Jesse Tack () and Jeffrey LaFrance ()

No 56412, 2010 Annual Meeting, February 6-9, 2010, Orlando, Florida from Southern Agricultural Economics Association

Abstract: Farmland and capital are an important and rapidly expanding component of the agricultural economy, and empirical evidence suggests that these assets are quasi-fixed in that adjustment costs are incurred when holdings are altered. Increased interest in the rate of return for investing in farmland suggests that an important consideration is the effect of adjustment costs on this return. A novel theoretical model is developed that ties together contributions from the farmland pricing and adjustment cost literatures, and the first order conditions for a utility maximizing decision maker are rearranged into intertemporal arbitrage equations that are similar in spirit to traditional finance models. The common assumptions that land and capital are quasi-fixed assets, and that production is characterized by constant returns to scale are tested and the evidence supports these assumptions. An empirical application of the arbitrage equations provides evidence that risk aversion and adjustment costs are jointly significant components of agricultural production, and that adjustment costs generate significant changes in the rate of return to farmland. The results have important policy implications as sluggish supply response due to quasi-fixity can lead to dramatically inflated commodity prices, and an accurate measure of the farmland return can help determine how far the extensive margin will expand or contract in response to a variety of policy scenarios, such as the subsidization of corn for ethanol, an increase in the variety of subsidized crop insurance products, or the introduction of new revenue support programs such as ACRE.

Keywords: Agricultural Finance; Consumer/Household Economics; Crop Production/Industries; Farm Management; Financial Economics; Land Economics/Use; Production Economics; Risk and Uncertainty (search for similar items in EconPapers)
Pages: 65
Date: 2010-01
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Persistent link: https://EconPapers.repec.org/RePEc:ags:saea10:56412

DOI: 10.22004/ag.econ.56412

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