Presentation at the FAC/IDS food price workshop, February 2012 http://www.future-agricultures.org/events/food-price-volatility

1. Measuring volatility and its impact
Xavier Cirera
Date: 02:02:2012

2. Outline
Volatility measurement
Volatility impact
Volatility differences
Volatility causes
Some final thoughts

3. Measures of volatility
Main measures of variations in agricultural prices over time
Unconditional standard deviation of prices over a period of time –
assume that past realizations of level and volatility do not affect future
realization – ignores distinction between predictable and unpredictable
price changes – some changes are predictable
Key question is whether we are interested in all price variability or only
on the unpredictable part
Test for whether price series are trend or difference stationary –in first
case shock has temporary effect in second cases shocks are permanent
– (problem when there is a structural break)
Easy solution de-trend prices – predictable part captured by a time trend
and unpredictable by the error term – volatility is defined as the variance
of the error term

4. Measures of volatility
More sophisticated measures
Autoregressive Conditional Heteroskedasticity (ARCH) or
Generalized Autoregressive Conditional Heteroskedasticity
(GARCH) – future prediction is conditional to previous realizations
– Based on an AR model estimates volatility based on a function
of the past residuals (ARCH) and past volatility (GARCH)
– The predictable part is modelled according to past realizations
– Lower volatility than unconditional measures
   0   e  ...  e
t
2 2
1 t 1
2
p t p
   0   e  ...  e  1 1  ...  p p
t
2 2
1 t 1
2
p t p
2 2

5. Volatility impact
Why volatility matters?.... Not obvious
The impact depends on capacity of producers to affect prices, pass-
through to producers and consumers and the degree of risk aversion.
Unpredictable volatility creates risk for producers and consumers –
sub-optimal decisions for production, investment and consumption
Farmers without access to financial services may not be able to
transfer income from one period to another, therefore household
welfare and farm viability is there threatened by large volatility.
Farmers will invest in inputs and as risk increases substantially reduce
investments, which will have negative long-term impacts on farm
productivity

6. Volatility impact
For whom matters most?.... Not obvious
Clear negative impact on producers and on misallocation of resources
The impact on consumers will depend on their capacity to adjust and
substitute goods in their consumption basket – theoretically depending
on income and price elasticy of demand and risk aversion, consumers
could benefit from price volatility (evidence?)
Speculators can benefit from price volatility
Impact is complex - most rural households are both producers and
consumers
However, it is important to keep in mind that the distributional impact of
volatility may be quite different from the distributional impact of high
food prices

7. Volatility differences
Volatility depends on price transmission, which depends on:
– how well integrated markets are, globally and nationally;
– whether countries are net importers or net exporters; and
– the extent of government interventions and price distortions
Volatility of producer prices tends to be larger than volatility of
consumer prices
Volatility of domestic prices (what should matter most) use to be
larger than volatility of international prices – but some evidence
that this has changed in recent years – different sources of
volatility

8. Volatility causes
Climate change shocks
Demand shocks
Link with energy markets
Traders activity and speculation
Depleted stocks making price management difficult
Government policies - export restrictions, import tariffs,..
It is important to distinguish the impact of these factors on the price level
and on price volatility
Also each determinant has very different implications for policies to
reduce volatility – difficult to manage the impact climate change
shocks, or more importantly large demand shocks

9. Some final thoughts
Important to separate conceptually food price volatility from high food
prices – this is important to understand the welfare effects and the
policy responses
But clearly both are correlated, so key question (for me) is whether
price volatility matters more when price levels are high? (for example
by making more difficult for producers to take advantage of high
prices)
Some important question for discussion:
- For whom volatility matters and what is the main impact?
- What causes volatility and how this relates to high food prices?
- What are the main policy options to reduce volatility?

10. THANK YOU