The Development Of Contract Agriculture And The Innovation On Financial Marktes

Since the 1980s', contract agriculture has shown its unique function in alleviating the contradiction between "small production" and "large markets", reducing the blindness of farmers' decision-making, reducing the operation costs and risks in agriculture industrialization, and increasing farmers' income. However, with the development of internationalization and deepening of the market economy in China, more and more problems are uncovered, especially the high default rate. Generally, the research into the high default rate in contract agriculture focus on is forms, effects, obstacles in its development and solutions, using tools such as Corporation Organizing Theory, Contract Theory, Game theory and Transaction Cost Theory. It is noticeable that, although scholars have done a lot of helpful research into the causes and solutions to the high default rate, the situation is not ameliorated. The breach of contracts would not only harm companies and farmers' enthusiasm of participating in the contract agriculture, but also impede the process of the modernization of Chinese agriculture markets. As a result, the research into the risk management in the development of contract agriculture from the perspective of financial innovation would not only be theoretically reasonable, but also provide instruction to the development of the contract agriculture in China.This paper puts contract agriculture into modern financial frame, and then seeks the sources of the high default rate in contract agriculture and upgrades the fundamental route of reducing the breach of contracts from the perspective of the evolution of financial derivatives. This perspective is different from the majority of current researches, which focus mostly on the development of contract agriculture, but not on the way to manage the risks implied in contract agriculture. For the moment, such solutions to remove the obstacles in the development of contract agriculture as to consummate the management mechanism and the contract forms, and to increase the investment of exclusive assets, are actually helpful to some extent. But they cannot solve the problem fundamentally. Because the solutions mentioned above cannot disperse risks, so that the risks implied in contract agriculture only transfers between the trading subjects inside the contract agriculture system. This technique, to some extent, is blocking the risk. However, in modern markets, the risks in agriculture can be magnified unlimitedly by the variety of financial derivatives used by investors or speculators. Thus, the financialization of agriculture risk is more and more apparent. The lack of withdrawal mechanism, the inherent risk accumulating mechanism, as well as the occlusion of the trading system, the limited amounts and information make it impossible for us to use forward contracts to avoid, transfer and disperse market risks. Thus, contract agriculture, with the properties of forward contracts, interacts with the new fmancialized agriculture risks. As a result, the conflicts will happen frequently and drastically. This in turn becomes the main inducement of the high default rate in contract agriculture. The evolvement of financial derivatives is the gaming process of individual interest and collective interest, is the way from confliction to harmony, and shows that the effective institutional arrangement is the key to the harmonization. Hence, to keep the fulfillment of the contracts fundamentally, the right way is not to block but to dredge, that is, on the basis of the traditional blocking methods, we should seek channels to externalize and fluidify the risks by financial innovation and effective institutional arrangements.This paper attaches great importance to the financialization of agriculture risks and the price finding, risk dispersing and distributing function of modern financial markets, as well as their inspiration to contract agriculture. Compared with spot contract and forward contract, futures is more efficient in price finding and more flexible. We deem that farmers can decide the contract price according to the futures' price, and make decisions about production and consumption. So that the blindness in their production can be avoided, and the farmers' interests can be protected practically. At the same time, inferring from the evolving law of financial derivatives, the option pricing theory also sheds lights upon the development of contract agriculture. Traditional option pricing models do not reflect the unusual movement in the economy; this does not match the farming production features. But Merton (1976)'s European call option pricing formula, concerning the geometric Brownian motion random process, involves not only the random factors but also the unusual factors. Thus, it is adaptive to prices of agriculture products and can help form reasonable contract prices and interest distributing systems between companies and farmers.The financial derivatives markets are changing the risk characteristic of a lot of industries and the risk management structure of the whole financial system, because of the accuracy, efficiency, openness, flexibility and low cost of the risk management on derivatives markets. Based on the analysis of risk distribution mechanism of futures and option markets, we structured the risk externalization channels, including futures contracts, option contracts, future option contracts, so that the socialization, standardization, and financialization of the contract agriculture risk management can be realized. Under the future contracts mode, the company and the farmer sign the contract, and at the same time hedge their own positions on futures market, in order to neutralize their risk exposure. This can improve the fulfillment of contracts fundamentally. However, because of the linearity in risk and profit, and the compulsory delivery system, future contract traders also lose the possibility of profit-making while transferring the risks, thus, the attraction of breach of faith is not completely eliminated. Option contracts, due to their non-linearity between risk and profit and the possibility of combination of kinds of derivatives, make the linear risk faced by companies and farmers changes fundamentally, so that they can better hedge, the profit can be managed steadily, and the tendency to break the contracts can be eliminated fundamentally. Based on the research and development of foreign financial derivatives, we also made some expectation to the prospect of risk management in contract agriculture. The credit risk and natural risk in contract agriculture also has to be managed in financial ways. The credit risk in contract agriculture can be peeled off and standardized, and then be distributed in credit derivatives market. Also, the natural risk can be standardized and distributed thought weather derivatives market. And this will be the focus of future research work. This paper also makes detailed discussion about the obstacles to the effective implement of the new future contracts and option contracts. We think that as long as the family contract system is dominant in China, specialized farmers' cooperatives are a shortcut for the contract agriculture participants to enter the modern financial markets. Let the hot money share the farming risk, in order to form reasonable risk and profit distribution mechanism for contract agriculture. This method is a necessity of the evolvement of farming contracts, and the best choice in order to break through the contradiction between small production and large market, and to realize the financial management of farming risk. On the basis of researches in existence, we devised kinds of connection patterns between agriculture contract participants, cooperatives and derivatives markets, and analyzed the problems and the tendency of future innovations.Finanlly, based on the present market situation and the necessities to keep the sustainable development of contract agriculture, this paper raised some policy advices about consummating the derivatives market, inaugurating the specialized farmers' cooperatives, and facilitating the effective connection between the agriculture contracts and derivative markets, so that the reasonable risk and profit allocation mechanisms can be structured, and contract agriculture can develop in a healthy, orderly, and sustainable way.