Incorporating Uncertainty into USDA Commodity Price Forecasts

Abstract

From 1977 through April 2019, USDA published monthly season-average price (SAP) forecasts for key agricultural commodities in the form of intervals meant to indicate forecasters’ uncertainty, but without attaching a confidence level. In May 2019, USDA eliminated the intervals and began publishing a single point estimate — a value that has a very low probability of being realized. We demonstrate how a density forecasting format can improve the usefulness of USDA price forecasts, and explain how such a methodology can be implemented. We simulate 21 years of out-of-sample density-based SAP forecasts using historical data, with forward-looking, backward-looking, and composite methods, and we evaluate them based on commonly-accepted criteria. Each of these approaches would offer USDA the ability to portray richer and more accurate price forecasts than its old intervals or its current single point estimates. Backward-looking methods require little data and provide significant improvements. For commodities with active derivatives markets, option-implied volatilities (IVs) can be used to generate forward-looking and composite models that reflect (and adjust dynamically to) market sentiment about uncertainty — a feature that is not possible using backward-looking data alone. At certain forecast steps, a composite method that combines forward- and backward-looking information provides useful information regarding farm-level prices beyond that contained in IVs.

Keywords: USDA, forecasting, derivatives markets, option-implied volatility, situation and outlook, WASDE, grains

JEL Classification: Q13, Q11