Determining Implicit Option Premiums for Government Farm Program Payments

Abstract

In order to satisfy trade agreement obligations, U.S. farm policy has been increasingly moving away from market-distorting direct subsidies to decoupled payments. Decoupling payments from production of specific commodities were designed to be non-distorting to producers’ production decisions. However, by altering producers’ price and revenue distributions, farm programs may distort producers’ production decisions. Recent U.S. government farm program payments are intended to provide a safety net protecting against adverse price and revenue events. As such, these programs act as put options for producers. The first step in assessing the potential for distortion is evaluating the implicit premiums of options provided by government programs. Option pricing models are developed for four recent U.S. farm programs, ACRE, DCP, ARC, and PLC, and are then used to estimate expected payments and implicit option premiums provided to producers under the programs.