ISSN 2280-6180 (print) © Firenze University Press 
ISSN 2280-6172 (online) www.fupress.com/bae

Bio-based and Applied Economics 2(3): 213-236, 2013

Food commodity price volatility and food insecurity

AlexAnder SArriS*1

University of Athens, Greece

Abstract. The paper first reviews several issues relevant to global food commodity 
market volatility as it pertains to food security, and food importing developing coun-
tries, and then discusses international and national policies and measures to prevent 
or manage this volatility and related risks. It is shown that market volatility relates 
to unpredictability of market fundamentals, and price spikes occur when unpredict-
ability increases excessively. The food security risks faced by food import developing 
countries are discussed and it is highlighted that the major risks involve not only large 
and unpredictable price variations but also trade finance as well as import contract 
enforcement. The problem of identifying a price spike is analyzed and it is seen that, 
despite difficulties in commodity modeling, there are empirical techniques that allow 
the assessment of the probabilities of price spikes, and could facilitate the triggering of 
responses. Suggestions are made concerning institutions and policies to assist develop-
ing countries better cope with the risks of commodity market volatility. 

Keywords. Agricultural price volatility, developing countries, food insecurity. 

JEL Codes. Q11, Q17, Q18

1. Introduction

The period since 2006 has seen considerable instability in global agricultural markets. 
Between September 2006 and February 2008, world agricultural commodity prices rose by 
an average of 70 percent in nominal dollar terms, with prices in some products rising by 
much more than that. The strongest price rises were observed in wheat, maize, rice, and 
dairy products. Prices fell sharply in the second half of 2008, although in almost all cases 
they remained above the levels of the period just before the sharp increase in prices started. 
In 2010 sharp price rises of food commodity prices were observed again, and by early 2011, 
the FAO food commodity price index was again at the level reached at the peak of the price 
spike of 2008. In 2011 and 2012 prices fell again and then rose again considerably in early 
2013. In other words within the past six years many food commodity prices increased very 
sharply, subsequently declined equally sharply, and then again increased rapidly to reach the 
earlier peaks. Such rather unprecedented volatility in world prices creates much uncertainty 
for all market participants, and makes both short and longer term planning very difficult. 

* Department of Economics, University of Athens, Greece, 8 Pesmazoglou street, Athens, 10559, Greece. Email 
alekosar@otenet.gr, asarris@econ.uoa.gr. Tel no. +30 6944 291796.



214 A. Sarris

The sudden and unpredictable increases in many internationally traded food commod-
ity prices in late 2007 and early 2008 caught all market participants, especially governments 
of net food importing developing countries, by surprise and led to many short term poli-
cy reactions that may have exacerbated the negative impacts of the price rises. Given that 
several such interventions were in many cases inadequate or inappropriate, many govern-
ments, think tanks, and individual analysts called for improved international mechanisms 
to prevent and/or manage sudden food price rises. Similar calls for improved disciplines of 
markets were made during almost all previous food market price bursts, but were largely 
abandoned after the spikes passed, largely because they were deemed difficult to implement. 
The purpose of this paper is first to review several issues relevant to global food commodity 
market volatility as it pertains to food security, and then to discuss international and nation-
al policies and measures to prevent or manage this volatility and related risks, mainly, albeit 
not exclusively, from the perspective of food commodity dependent developing countries.

Staple food commodity price volatility, and in particular sudden and unpredictable 
price spikes, creates considerable food security concerns, especially among those, individ-
uals or countries, who are staple food dependent and net buyers. These concerns range 
from possible inability to afford increased costs of basic food consumption requirements, 
to concerns about adequate supplies, irrespective of price. Such concerns can lead to reac-
tions that may worsen subsequent instability. For instance excessive concerns about ade-
quate supplies of staple food in exporting countries’ domestic markets may induce gov-
ernments to take measures to curtail or ban exports, thus inducing further shortages in 
world markets and higher international prices. The latter in turn may induce permanent 
shifts in production and/or consumption of the staple in net importing countries, with the 
result that while subsequent global supplies may increase, import demands may decline 
permanently altering the fundamentals of a market. 

The recent food market spike and volatility occurred in the midst of another impor-
tant longer term development, that highlights additional developing country concerns. 
Over the last two decades there has been a shift of developing countries from the position 
of net agricultural exporters up to the early 1990’s to that of net agricultural importers 
(FAO, 2006). Growing dependence on food commodity imports implies growing vulner-
ability to external commodity shocks. Projections to 2030 and 2050 indicate a deepening 
of this trend (ibid.), which is due to the projected decline in the exports of traditional 
agricultural products, such as tropical beverages and bananas, combined with a project-
ed large and growing deficit of basic foods, such as cereals, meat, dairy products, and oil 
crops. Since 1990, the food import bills of least developed countries (LDCs) have not only 
increased in size, but also in importance, as they constituted more than 50 percent of the 
total merchandise exports in all years. In contrast, the food import bills of other develop-
ing countries (ODCs) have been stable or declined as shares of their merchandise exports. 
These trends were reinforced during the 2007-8 food crisis (Prakash, 2011). 

The above suggests that the problem of managing the risks of food imports has 
increased in importance, and is already a major issue for several LDCs and low-income 
food deficit countries (LIFDCs)2. The major problem of LIFDCs is not only price or quan-

2 LIFDCs are a FAO classification. The latest list of May 2012 includes 62 countries. The list of LDCs is one used 
by the United Nations (UN) and as of 2012 includes 49 countries. Almost all LDCs are also included in the 



215Food commodity price volatility and food insecurity

tity variations per se, but rather major unforeseen and undesirable departures from expec-
tations, that can come about because of unanticipated food import needs due to unfore-
seen adverse domestic production developments, as well as adverse global price moves. 
In other words, unpredictability is the major issue. This is also the gist of the argument 
of Dehn (2000a) and Cavalcanti, et. al. (2011) who argued that the negative impacts on 
growth of commodity dependent economies come from unanticipated or unpredictable 
shocks, rather than from ex-post commodity instability per se. 

Apart from the problem of unpredictability of food import bills for LIFDCs, anoth-
er problem that surfaced during the recent food price spike was the one of reliability of 
import supplies. Several net food importing developing countries (NFIDCs) that could 
afford the cost of higher food import bills, such as some of the middle income oil export-
ing countries and small island states, during the 2007-8 period faced problems of not 
only unreliable import supplies but also the likelihood of unavailability of sufficient food 
import quantities to cover their domestic food consumption needs. This raises a differ-
ent problem for these countries, namely the one of assurance of import supplies. Several 
of these countries, e.g. those surrounding the Arab Peninsula and the Persian Gulf, have 
unfavorable domestic production conditions and rely on imports for a substantial share of 
their domestic consumption, as indicated in table 1. Unavailability of supplies creates large 
food security concerns for these countries. 

The rest of the paper proceeds as follows. In the next section the issue of market 
volatility and its importance are examined. Section 3 considers the issue of the types 
of risks faced by food importing developing countries. In section 4 the issue of how to 

LIFDC list. The list of NFIDCs is a World Trade Organization (WTO) group, which as of 2012 includes all 49 
LDCs and another 31 higher income developing countries, for a total of 80 countries. 

Table 1. Cereal import dependence 2007-9 (number of countries with percentage share of imports to 
total domestic supply in given range).

0-10  10-20 20-50 50-75 75-100
Total No of 
countries in 

group

HIC 5 3 6 22 36
LDC 16 6 12 9 6 49
LIC 18 6 16 8 1 49
MIC 16 6 28 14 20 84
OIL EXPORTERS 3 1 6 1 4 15
SIDS 1 4 6 31 42

Total No of 
countries 58 20 69 44 84 275

HIC-High income countries, MIC-middle income countries, LIC-low income countries,(World Bank defi-
nitions), SIDS=small island developing states, LDC-least developed countries (UN definitions). Some 
countries in the LDC, Oil exporter and SIDs groups are included in the other categories as well. 
Source. Author’s computations from FAO data.



216 A. Sarris

prevent or lower the occurrence of market volatility and crises is considered. The final 
section concludes. 

2. What is market volatility and why it matters

Market volatility normally refers to variations of market prices from period to period. 
As such it is an ex-post concept, in the sense that everyone can observe the market vari-
ations. However, what matters for both market participants as well as policy makers are 
not the market price variations per se, but their unpredictability, and the risks they cre-
ate. Uncertainty of the variable x, when looked at from some period before its realization, 
is basically a summary measure of the unpredictable elements in the process determin-
ing x, that are likely to occur between the time of the prediction and the time of realiza-
tion of the variable x. For instance if a producer is contemplating producing a crop, he/
she may know the basic process (the model) that determines the yield and the price of the 
commodity, but he also knows that there are elements of this process, such as rainfall and 
future price, that cannot possibly be predicted say one year ahead. These unpredictable 
elements are what create the uncertainty about the outcome of his action to produce the 
crop. Uncertainty then depends on how far into the future one is interested in the variable 
of interest. In the sequel uncertainty and upredictability are used interchangeably as they 
refer to the same concept. 

Risk, in turn is generated by uncertainty. In other words risk is generated by actions 
whose outcomes are subject to unpredictability. In the case of the producer, he knows that 
production of a crop is uncertain. As long as he does not produce the crop he is not at 
risk. If, however, he decides to produce it, he places himself at risk, as the outcome of the 
crop affects his income and welfare. Thus it is unpredictability that defines uncertainty, 
and it is the actions that have uncertain outcomes that create the attendant risks. In the 
face of uncertain outcomes and prices, agricultural producers, for instance, tend to reduce 
the risks facing them, by diversification, namely by producing a less uncertain mixture of 
products.

Prices normally fluctuate in commodity markets in response to new and continuously 
changing information about the state of the markets. Similarly the underlying uncertain-
ty about future events gives rise to expectations about future market outcomes, such as 
prices, and different degrees of confidence about these expectations. Hence at any point in 
time one can talk about the underlying uncertainty of the market about a future outcome. 
The level of information and the actions of the various market participants based on this 
information determine the probability distribution of expectations as well as actual mar-
ket outcomes. It is normal in commodity markets that actual prices vary from period to 
period, and also that expectations of market outcomes, such as prices, also vary. 

Volatility is normally associated with two concepts. The first is variability of the 
observed prices, and as such it is a concept that can be readily quantified ex-post through 
some a measure based on observable market prices. The second concept is that of unpre-
dictability, and this, at any one time, refers to the conditional probability distribution of 
some subsequent market outcome, given current information. Such a concept cannot be 
readily and objectively quantified, as there is no corresponding market variable. It can 
only be inferred from observed market variables through some appropriate model. 



217Food commodity price volatility and food insecurity

The principal concern of market participants and policy makers alike is not large ex-post 
variations in observed prices per se, but large shifts in the degree of unpredictability or uncer-
tainty of subsequent prices. Such large shifts normally also cause large changes in observed 
market prices and are associated with what has been termed “excess volatility” (Shiller, 1981, 
Prakash, 2011), a rather elusive concept referring to variations of prices outside what maybe 
inferred or predicted on the basis of expectations of rational efficient markets. 

A very popular measure of ex-post or realized or historical market volatility, used 
extensively in finance, is the annualized historic volatility, computed as the standard devi-
ation of the logarithmic returns of prices over a given period of time multiplied by the 
square root of the frequency of observations.

€ 

v = σ T , where 

€ 

σ = (ri − µ)
2

i=1

n

∑ /(n −1) , and 

€ 

rt = ln(Pt) − ln(Pt−1)  (1)

In the above rt is the logarithmic return of price, P is the (detrended) price of the com-
modity, n is the number of observations, µ is the average of the logarithmic returns, and T 
is the frequency of the observations on a yearly basis (252 if daily3, 12 if monthly, etc.). 

Unpredictability in turn is not easily measured as indicated above. One relatively 
objective measure of unpredictability is “implied volatility”, which is a measure of the 
market estimate of the ex-ante or conditional variance of subsequent price, based on cur-
rent observations of values of options on futures prices in organized exchanges, and using 
the Black-Scholes model for the computations. Estimates based on the two concepts may 
point in different directions, depending on data. For instance illustrations in Prakash 
(2011) indicate estimates of realized volatilities of cereals, based on observed spot prices 
in major international markets, such as Gulf (as compiled by FAO), which exhibit mild 
upward trends, while estimates of implied volatilities of the same cereal prices, as inferred 
from option prices in the major exchange trading these derivative instruments, namely 
Chicago Mercantile Exchange (CME), exhibit strongly upward trends. This suggests that 
there maybe different determinants of the ex-post and the ex-ante volatilities of food com-
modities depending on the market where prices are measured. 

Unfortunately there are not many organized commodity options markets, and hence 
implied volatilities cannot be estimated from readily observed option prices for most 
commodities. However, there are other ways to measure unpredictability. A popular meas-
ure is an estimate of the conditional variance of future price, based on a time series model 
of the price. Models of prices that allow direct estimation of such conditional variances 
are the class of Generalized Autoregressive Conditional Heteroscedastic time series mod-
els (GARCH), introduced by Bollerslev (1986). 

The detrimental effects of uncertainty or unpredictability on both private agents, as 
well as governments are not hard to understand, and have been the object of both discus-

3 252 refers to the number of trading days within a year



218 A. Sarris

sion as well as research for a long time. For instance, Keynes (1942) argued that commod-
ity price fluctuations led to unnecessary waste of resources, and, by creating fluctuations 
in export earnings, had a detrimental effect on investment in new productive capacity, and 
tended to perpetuate a cycle of dependence on commodities, what we may call in modern 
growth terminology a “commodity development trap”. 

The above discussion implies that mere ex-post variability of outcomes does not con-
stitute uncertainty, which is inherently an ex-ante conept. This issue of uncertainty ver-
sus mere ex-post variability is important in the discussion of this paper, as compensatory 
schemes like STABEX, as well as the IMF’s Commodity Compensatory Financing Facility 
(CFF) have adopted a notion of uncertainty that is related to the mere ex-post variability 
or fluctuations of outcomes such as export earnings or import costs, rather than to their 
predictability. More recently, there have been efforts to construct indices that correspond 
more closely to the theoretical notion of uncertainty, namely the notion of unpredict-
ability. Dehn (2000b), constructed an index of price instability that distinguishes between 
negative and positive shocks, and finds, as expected theoretically, that negative commod-
ity price shocks have a significant negative effect on overall economic growth. This was 
the first study to establish a strong negative empirical link between negative unanticipated 
shocks and overall economic growth. Recently Cavalcanti et. al. (2011) also estimated that 
negative terms of trade shocks (which include high food import costs) have stronger nega-
tive growth impacts than positive terms of trade shocks for developing countries. 

That unpredictability rather than instability is the main problem in agricultural pro-
duction is one of the oldest, but apparently forgotten or not appreciated, issues in agricul-
tural economics. In fact one of the earliest classic works in agricultural economics con-
sidered exactly the issue of agricultural price unpredictability and the benefits of estab-
lishing forward prices for producers (Johnson, 1947). By establishing forward prices for 
agricultural producers, one basically eliminates one of the most troublesome and poten-
tially damaging sources of income unpredictability, and makes producers able to plan bet-
ter their activities. 

Establishing predictability in agriculture has been one of the earliest institutional 
developments of the modern era in developed countries. In fact the modern US agricul-
tural marketing system realised very early the benefits of a market based system of for-
ward prices, and through the simple system of warehouse receipts, emerged one of the 
most sophisticated and useful marketing institutions in modern agriculture, namely the 
institution of futures markets. It is not perhaps coincidental that futures markets devel-
oped independently in several countries and long time ago. In more recent years, the 
development and globalisation of financial markets has led to the proliferation of many 
other risk management commodity related instruments, notably options, and weather 
related insurance contracts. While in some developed countries the marketing system 
response to unpredictability has been the establishment of sophisticated forward mar-
kets, in most other countries, both developed and developing, the response of producers, 
and through their pressure of governments, has been the institution of fixed or minimum 
price marketing arrangements. The major problem, however, of most such schemes is not 
that they are in principle wrong, but that they have most often been transformed to price 
support or taxation instruments that have veered off their purpose of providing forward 
signals and minimum prices based on proper predictions. 



219Food commodity price volatility and food insecurity

It, therefore, appears that a major issue in post adjustment agriculture in most devel-
oping countries, with respect to market volatility, is how to establish some forward pricing 
or insurance system for agricultural producers and governments without distorting the 
markets. Once such forward mechanisms can be established then one can talk about sys-
tems of insurance or systems of compensation.

Considerable literature has been devoted to understanding the costs of market vola-
tility. Prakash (2011) offers a thorough survey. While some literature (Lucas, 2003) sug-
gested that the cost of market volatility is quite small in developed countries with efficient 
capital markets, other literature, that took into account credit constraints and imperfect 
transmission from international to domestic markets, showed that the cost of market 
volatility can be substantial for low income developing countries exposed to commodity 
shocks (Guillaumont, et. al., 1999, Prasad and Crucini, 2000, Subervie, 2008, Rapsomani-
kis and Sarris, 2008, Bellemare, et. al. 2010).

3. Volatility risks faced by food importers 

Policies for the effective management of price booms or general market volatility 
depend on the proper identification and assessment of the risks facing each country. These 
differ by country, and involve the identification of the parts of a country’ s economy and 
inhabitants that are vulnerable to food commodity market shocks, as well as the types of 
market uncertainties which affect these agents. In other words one must outline a “risk 
profile” of the country to food commodity shocks. In the sequel risks that depend on 
upheavals in international food markets are discussed. 

Proper response to a food commodity shock differ depending on whether the shock 
affecting the country is transitory or permanent. Factors to consider are the follow-
ing: (i) Does the price shock have its origins in factors external to the country, such as 
world markets, or in domestic production supply imbalances in the markets concerned? 
(ii) How transitory are the factors that have led to the price shock? (iii) What is the level 
of uncertainty concerning the factors that may influence the future course of prices? The 
answers to these questions are not easy, and there may be legitimate differences of opinion 
among analysts concerning such assessments.

The second issue concerns the possible impacts of the price shock on the country’s 
economy and its citizens. The impact of increasing prices on the wider economy is deter-
mined by a number of structural characteristics, such as the structure of production and 
food consumption, and the types and income-consumption profiles of households. Any 
adopted policy measure should not try to protect or benefit one vulnerable group by dam-
aging the benefits to another poor constituency. In this context, it is important to ascer-
tain the extent to which price signals are transmitted to the domestic markets, the iden-
tification of vulnerable population groups that can be targeted for support, as well as the 
agricultural sector’s ability to respond to increasing prices. 

The third issue that is imperative before a country adopts specific policy measures is 
to ascertain and be clear about the objective of the policy. Too often policy measures are 
adopted with a very narrow objective, and may end up affecting negatively other areas of 
equally important domestic concern. Also if the objective is known and generally agreed 
upon, then any policy measure can be judged against others that may offer similar ben-



220 A. Sarris

efits, but with smaller side effects or negative secondary consequences. Finally, if there are 
more than one policy objectives, it may well be that a combination of measures is neces-
sary to simultaneously achieve all of them. 

The reactions to the recent price boom, suggest that policy reactions to the food 
price surge have been prompt, with governments in many developing countries initiating 
a number of short-run measures, such as reductions in import tariffs and export restric-
tions, in order to harness the increase in food prices and to protect consumers and vul-
nerable population groups. Other countries have resorted to food inventory management 
in order to stabilize domestic prices. A range of interventions have also been implement-
ed to mitigate the adverse impacts on vulnerable households, such as targeted subsidized 
food sales (Rapsomanikis, 2009).

Demeke, et. al. (2011) made a review of policies adopted in response to the recent 
food price spike and they indicate that the responses of developing countries to the food 
security crisis appear to have been in contrast to the policy orientation most of them had 
pursued over the last decades as a result of the implementation of the Washington consen-
sus supported by the Bretton Woods Institutions. This period had been characterized by 
an increased reliance on the market – both domestic and international – on the ground 
that this reliance would increase efficiency of resources allocation, and by taking world 
prices as a reference for measuring economic efficiency. The availability of cheap food on 
the international market was one of the factors that contributed to reduced investment 
and support to agriculture by developing countries (and their development partners), 
which is generally put forward as one of the reasons for the recent crisis. This increased 
reliance on markets was also concomitant to a progressive withdrawal of the state from 
the food and agriculture sector, on the ground that the private sector was more efficient 
from an economic point of view.

The crisis has shown some drawbacks of this approach. Countries depending on the 
world market have seen their food import bills surge, while their purchasing capacity 
decreased, particularly in the case of those countries that also had to face higher energy 
import prices. This situation was further aggravated when some important export coun-
tries, under intense domestic political pressure, applied export taxes or bans in order to 
protect their consumers and isolate their prices from world prices. 

As a result, several countries changed their approach through measures ranging from 
policies to isolate domestic prices from world prices; moving from food security based 
strategies to food self sufficiency based strategies; by trying to acquire land abroad for 
securing food and fodder procurement; by trying to engage in regional trade agreements 
or; by interfering with the private markets through price controls, anti-hoarding laws, 
government intervention in output and input markets, etc.

Before one discusses any mechanism to manage food import risks it is important to 
ascertain the types of risks that are relevant to food importers. Food imports take place 
under a variety of institutional arrangements in developing countries. A study by FAO 
(FAO, 2003) contains an extensive discussion of the state of food import trade by develop-
ing countries. It notes that while in some LIFDCs state institutions still play a very impor-
tant role in the exports and imports of some basic foods, food imports have been mostly 
privatized in recent years, although with some exceptions, and in some countries, state 
agencies operate alongside with private importers. 



221Food commodity price volatility and food insecurity

A public sector food importer, namely a manager of a food importing or a relevant 
food regulatory agency each year faces the problem of determining the requirements 
that the country will have to satisfy the various domestic policy objectives. Such objec-
tives may include domestic price stability, satisfaction of minimum amount of supplies, 
demands to keep prices at high levels to satisfy farmers, or low to satisfy consumers and 
many others relevant to various aspects of domestic welfare. The problem of the manager 
of the food agency is four-fold. First there needs to be a good estimate of the require-
ments, which is not easy given uncertainties in estimations of domestic production and 
demand. Secondly, the public sector food agency manager, must decide how to fulfill 
them, namely through imports, or by reductions in publicly held stocks, if stock hold-
ing is part of the agency’s activities. A related problem is the risk of non-fulfillment of 
the estimated requirements which may cause domestic social problems and food insecu-
rity. The third problem of such an agent is how to minimize the overall cost of fulfilling 
these requirements, given uncertainties in international prices and international freight 
rates, and to manage the risks of unanticipated cost overruns. For instance, if the agency 
imports more than is needed, as estimated by ex-post assessment of the domestic market 
situation, then the excess imports will have to be stored or re-exported and these entail 
costs. Finally, but not least, and related to the overall cost of fulfilling the requirements, 
the agent must finance the transaction, either through own resources, or through a variety 
of financing mechanisms. 

In many countries the State has withdrawn from domestic food markets, and it is pri-
vate agents who make decisions on imports. The problem, however, of private agents, is 
not much different or easier than that of public agents. A private importer must assess with 
a significant time lag, the domestic production situation, as well as the potential demand 
just like a public agent, and must plan to order import supplies so as to make a profit by 
selling in the domestic market. Clearly the private importer faces risks similar to those of 
the public agent, as far as unpredictability of domestic production, international prices, 
and domestic demand are concerned, and in addition faces an added risk, namely that of 
unpredictable government policies that may change the conditions faced when the product 
must be sold domestically. During the recent food price crisis, surveys by FAO document-
ed the adoption of many short-term policies in response to high global staple food prices, 
which must have created considerable added risks for private sector agents. Furthermore, 
the private agent maybe more credit and finance constrained than the public agent. In fact 
the study by FAO (2003) indicated that the most important problem of private traders in 
LIFDCs is the availability of import trade finance. The main external uncertainty facing 
food importers is international price variability and hence unpredictability. 

Once the level of imports needed is determined, there are two additional risks faced 
by import agents, apart from the price risk. The first is the financing risk, namely the pos-
sibility that import finance may not be obtainable from domestic of international sources. 
This is the risk identified as most crucial by the FAO (2003) study for agents in LIFDCs. 
The second risk is counterparty performance risk, namely the risk that a counterparty 
in an import purchase contact will default and fail to deliver. This latter risk is one that 
came to the fore during the recent price spike, and is can be due to both commercial and 
non-commercial factors. Commercial factors may include the inability for the supplier to 
secure the staple grain at the amount and prices contracted because of sudden adverse 



222 A. Sarris

movements in prices. Non-commercial factors includes things such as export bans, natu-
ral disasters or civil strife, in the sourcing country that may render it impossible to export 
an agreed upon amount of the staple. 

Market and price variability in agricultural commodities is a fact of everyday life, 
and most countries and agents have adapted to this reality. The issue, however, which 
is of concern is “excessive volatility”. Conceptually excessive volatility in a commodity 
should refer to unpredictable movements of price outside some bounds that are deemed 
to occur infrequently and are deemed to be undesirable. How can one define these 
bounds? A useful approach is to refer to the concept of risk layering which is well known 
in the field of risk management and insurance (see for instance World Bank, 2005). The 
idea applied in this context is to start by considering the probability distribution of prices 
or price changes. This could be a distribution based on historical observations. Then one 
could try to split the range of all possible prices into three intervals defined by a floor 
and a ceiling price level Pf and Pc. The choice of these upper and lower bounds could be 
made with the idea that markets would fail for prices above or below these bounds, and 
that occurrence of prices outside the bounds would be infrequent. This is what maybe 
termed the “market failure” risk layer. Prices in some range around the mean could be 
considered to define a “retention layer”, namely price variations that can be handled by 
agents without any additional measures or risk management instruments. The remain-
ing intermediate price ranges could be termed the “market insurance” risk layer, and the 
idea is that within these price ranges, there is a variety of market based risk management 
instruments that can be used to manage market risk. The range outside the minimum 
and the maximum bounds could then be considered as the “market failure level”, and 
excessive volatility could be defined as cases when prices fell in that range. Figure 1 illus-
trates the concepts, and figure 2 indicates how excessive market volatility could be meas-
ured with actual price series data. Clearly defining the relevant bounds is not straightfor-
ward, as it is not clear what level of prices constitutes market failure. The notion of fre-
quency maybe more applicable, but even then to agree on the frequency at which prices 
could be considered to be outside “normal” levels is not straightforward. Neverhteless, it 
is the principle that is illustrated here. 

4. Policies to manage market volatility and price spikes

Ηow can individual countries and the international community manage excessive 
market volatility? There are basically two ways in which individual countries can manage 
their domestic food markets in the face of excessive international market volatility. One 
involves trade actions, and the other involves public stockholding. If countries or other 
agents can be assured their commodity supplies through trade, then they would need to 
carry lower levels of security stocks. Hence trade can be an important substitute for carry-
ing costly physical inventories. Trade, however, can be impeded by a variety of problems. 
Policies aimed at facilitating commodity trade, may therefore obviate the need for poli-
cies to carry costly security or emergency physical stocks, both nationally and internation-
ally. In the recent as well as previous food crises, there were three major trade facilitation 
related problems that caused governments to examine carrying larger security stocks. The 
first concerned unexpected and uncoordinated export bans by key exporters, which tend 



223Food commodity price volatility and food insecurity

to increase international prices. The second was the unavailability of import financing for 
several lower income food importing countries, and the third was the uncertainty about 
international contract enforcement in a time of rising prices. The sequel discusses propos-
als to deal with these problems.

Figure 1. “Risk layers” of market prices.

 
	
  

Figure 2. Defining price spikes.

 
	
  



224 A. Sarris

Can export bans be prevented?

Export bans are very disruptive to international markets, as they disturb established 
trade flows and cause significant losses to traditional trading partners of the countries 
that import from those imposing export bans. As export bans are a trade measure, the 
appropriate international forum to discus this is the World Trade Organization (WTO). 
Currently export bans are not forbidden by the WTO agreement, as the concern of WTO 
members in the past was with low prices and hence import restriction measures, rather 
than high prices, which are reinforced by export bans. It would cost little to implement 
such an agreement among WTO members, once they agreed to it, and it would involve a 
small change in existing WTO rules. This, however, is not assured, as some members may 
not want to abandon the flexibility to control their domestic commodity markets via such 
an instrument. Clearly the developed countries would have a large role to play in revising 
the WTO rules in this direction. 

A fund for the establishment of an internationally coordinated “Global Financial Food Reserve” 
(or GFFR) of basic food commodities 

The only sure way to avoid excessive market upheavals is to have some amounts of 
previously accumulated stocks, but every proposal along these lines runs up against coor-
dination and financing problems. The idea of the proposal here is to combine the best 
parts of the two proposals on reserves that have been discussed considerably, namely 
the establishment of a coordinated global physical reserve and a virtual reserve aimed at 
calming futures market speculation. The idea is to have a market based global safety net 
which would create physical or financial resources in times of price spikes. 

The major problem with all proposals that have been proposed and deal with market 
volatility is that they purport to try to prevent the occurrence of a price spike. This, how-
ever, is very difficult to accomplish within a globalized market system, and may need very 
large and uncertain amounts of financial resources, that rightly makes donors uneasy and 
unwilling to consider. However, if the major objective of a system to deal with market vol-
atility is to prevent the weakest members of the international community from paying the 
price for an upheaval, which for the most part is not their fault, then one could consider 
a limited and much cheaper safety net system to ensure support only for those countries. 

The proposal made here would be an agreement by a group of a few important world 
grain market participants that would include members of the G8+5 as well as major 
grain exporters and other donors, to commit funds that could be utilized to hold speci-
fied amounts of publicly owned long positions in organized exchanges. In other words the 
proposal calls for the establishment of an international publicly held “global commodity 
fund” specifically targeted to basic foods. Given low margin requirements, this fund could 
assure, with relatively modest financial resources, control over a considerable amount of 
physical reserves. The idea is that a certain amount of financial resources would be used 
to initially buy an amount of long futures contracts in one or more basic grains. These 
contracts would be held and rolled over, when the time of expiration comes, and in addi-
tion there would be some additional funds to cover potential margin calls in the course of 
holding the long positions. This could then constitute a “virtual commodity reserve”, but 



225Food commodity price volatility and food insecurity

in its concept it is very different from what has been proposed before by von Braun and 
Torrero (2009), and von Braun et. al. (2009), as the fund would consist of committed long 
positions, and would basically act as dormant physical reserve. The fund’s positions would 
be rolled over from period to period, much like the commercial commodity funds do. 

The fund’s positions would be dormant and passive when markets are operating in 
normal conditions. Hence its resources would not be used for any “stabilization opera-
tions”, albeit, they maybe used to cover margin calls in periods when prices fall below the 
acquisition price. However, when markets go into an unusual spike, which could be sig-
naled by either the breeching of some prespecified price upper ceiling, the fund would have 
the option to either take physical delivery, so as to utilize the physical stocks for prespeci-
fied purposes, or to sell off the long positions. In either case the fund would command at 
a time of a price spike either physical stocks or financial profits from its long positions, 
if liquidated under market spike conditions. These physical stocks or profits could be uti-
lized to promote a global safety net to assist most affected poor countries in obtaining food 
commodity imports at lower than spiking market prices. In other words the fund and the 
stocks it could support would not be utilized for market or price stabilization but rather for 
supporting assistance to needy countries in times of global price spikes. 

Given that the fund’s purpose would not be to stabilize markets, but rather to assure 
market weak participants that their excess food import costs would be covered, the GFFR 
could be restricted in size to what is estimated as needed for additional or extraordinary 
assistance to needy food importing countries in times of a food crisis. 

The cost of such a reserve would be modest. For instance between 2006 and 2008 the 
total cereal import bill of LDCs increased by roughly 20 percent or about 4 billion US$. If 10 
percent of that could have been considered as extraordinary cost of vulnerable poor countries 
that would be compensated by developed countries as extraordinary aid under some global 
safety net, then this would amount to 400 million US$. This is much smaller than the funds 
that were committed by developed countries in support of developing countries in the con-
text of the global food crisis. If the fund before the crisis was of a size of 100 million US$, and 
it was all invested in cereal stocks via long future positions, then at 5 percent margin it would 
have commanded physical amounts, worth about 2 billion US$. The profits from a 20 percent 
increase in prices during the spike (and the actual increase during a spike would have been 
much larger than this) would then have been around 400 million US$, which would have 
allowed the fund to compensate some low income developing countries for the extraordinary 
costs of the import bills. Needless to say that these calculations are very quick and simple but 
are intended to give an order of magnitude to the amounts involved. 

The GFFR would act as a global market based safety net. As its major market opera-
tion would be to roll over positions in each period if needed, it would not interfere in the 
normal functioning of the commodity markets. The allocation of the proceeds or the prof-
its of the GFFR from any price spike to needy developing countries could be a separate 
process, that would entail allocation according to some prespecified development criteria. 

Food import financing and a dedicated food import financing facility (FIFF)

A major problem facing least developed countries (LDCs) and some net food import-
ing developing countries (NFIDCs) is financing for both private and parastatal entities of 



226 A. Sarris

food imports, especially during periods of excess commercial imports. The financing con-
straint arises from the imposition, by both international private financial institutions and 
domestic banks that finance international food trade transactions, of credit (or exposure) 
limits for specific countries or clients within countries. These limits can easily be reached 
during periods of needs for excess imports, or periods of high prices, thus constraining 
the capacity to procure finance for food imports and as a result, food import capacity. To 
this end a FIFF was proposed in 2005 to the WTO by FAO and UNCTAD and elaborated 
further by Sarris (2009), to overcome this problem. 

The purpose of a food import financing facility (FIFF) would be to provide financ-
ing to importing agents/traders of LDCs and NFIDCs to meet the cost of excess food 
import bills. The FIFF is not intended to replace existing financing means and struc-
tures; rather it is meant to complement established financing sources of food imports 
when needed. The financing will be provided to food importing agents. It will follow 
the already established financing systems through central and commercial banks, which 
usually finance commercial food imports using such instruments as letters of credit 
(LCs). The extra contribution of the FIFF would be to provide guarantees to these finan-
cial institutions so that they can increase their exposure to the importing countries. It 
will do so by inducing the exporters’ banks to accept the LCs of importing countries in 
hard currency amounts larger than their credit ceilings for these countries. A key aspect 
of the FIFF is that it will not finance the whole food import bill of a country, but only 
the excess part induced by a food crisis. In this way “co-responsibility” will be estab-
lished, so that only real and likely unforeseen needs will be financed, and the cost of 
excess financing will be kept at a low level.

The basic feature of the proposed FIFF is to provide the required finance at a very 
short notice, and exactly when needed, once the rules of operation are agreed upon in 
advance. Thus, the delays common to past ex-post insurance or compensation schemes 
that rely on ex-post evaluation of “damages” can be avoided. The proposed FIFF will oper-
ate in real time. Its financial strength would be based on guarantees provided to the FIFF 
by a number of countries or international financial institutions. 

The costs of a FIFF would be minimal through risk pooling for a large number of 
countries and food products, and low operational costs owing to its risk management 
activities. The principal risk for the FIFF is that the guarantees that it provides will be 
called to finance non-repayments. This risk could be managed actively. As the facility 
would not set out to disturb the normal functioning of international food trade, there is 
a “non-zero” risk that the local or central banks cannot be reimbursed by their local food 
importing clients. This would primarily be the concern of the domestic and central banks 
of each country, and not the FIFF. Nevertheless, lack of reimbursement by the ultimate 
beneficiaries of the finance may lead commercial banks to default on their obligations (or 
delay repayment) to the FIFF.

The FIFF would benefit from guarantees from a number of countries. Ideally, this 
would include a number of OECD countries, which would enable the FIFF to borrow at 
AAA terms, when needed. But any group of countries could provide guarantees; the risk 
rating of the FIFF is then likely to be that of the best-rated among these countries.

A food import financing facility has existed in the IMF since 1981 under the Com-
pensatory Financing Facility (the IMF CFF). The objective of that was not food import 



227Food commodity price volatility and food insecurity

financing, but rather compensatory financing to countries facing balance of payments 
problems, and hence could not import food. Despite its availability it has been utilized 
very little, largely owning to the conditionalities imposed on borrowers by the IMF. The 
proposed FIFF would be different from the CFF in the sense that it would provide guaran-
tees for normal food import finance, and would act in a much more timely fashion, name-
ly before the undesirable event, rather than after. 

While the FIFF envisioned in the current proposals is an international initiative, it 
could operate also as a policy of major food exporters, such as the EU, Canada and others. 
The US already operates a system very similar to this under its GSM-102 program of the 
Commodity Credit Corporation. The EU does not have a system of this type, despite the 
fact that many major agricultural commodity exporting firms and financial institutions 
operate in the EU. 

A drawback of the FIFF, as mentioned by Gilbert and Tabova (2011), would be the fact 
that potential donors would have to count the guarantees provided to the FIFF as part of 
their public debt, even though the guarantees may not be exercised, something that may 
not be easy for some donors. To this end it is helpful to make rough estimates of the types 
of amounts of guarantees needed. Sarris (2009) made some empirical estimates for the 
yearly guarantee needs that LDCs and LIFDCs would require under such a system and 
given the data for years up until 2007. The computations suggest that average yearly FIFF 
guarantee financing for LDCs would be in the vicinity of 200-430 million US$, while the 
financing needs in an exceptional year may reach as much as 2,400 million US$. To put 
these figures in perspective the average yearly LDC commercial food import bill for all 
foods between 2000 and 2007 was 10.7 billion US$. Hence the FIFF average annual financ-
ing and hence guarantee needs would constitute about 2-4 percent of yearly LDC com-
bined commercial food imports. In a year of exceptional needs, the value of FIFF guarantee 
financing needed could rise to as much as 23 percent of the total LDC food import bill. 

If all LIFDCs were to be covered by the FIFF, then the annual guarantee financing 
needed would be in the range of 960-1937 million US$, and this constitutes around 1.8-
3.7 percent of the average LIFDC food import bill for the period 2000-2007. In an excep-
tional year the maximum financing needed could rise to as much as 10 billion US$, which 
would be about 19 percent of the total LIFDC average food import bill of the same peri-
od. The above amounts are very small compared to the debt levels of the major donors, 
which, for instance for the US currently stands at around 14 trillion US$, for France to 
2 trillion US$, for Germany to near 2 trillion US$, etc. The G7 group of most developed 
countries currently has a level of public debt in the neighborhood of 20 trillion US$. 

A system to guarantee food import contracts

A problem that is acute during food crises is counterparty performance risk, namely 
the risk of reneging on a delivery contract, faced by many food importers. In other words, 
the problem in this case is not so much unpredictability of food import costs, or high 
food import prices, or financing, but rather assurance that supplies will be delivered. This 
does not only pertain to short term contracts but also longer term contracts. The basic 
reason for non-performance of international staple food import contracts is adverse price 
movements or adverse financial events that prevent a food exporter or trader to fulfill an 



228 A. Sarris

import contract. There seems to be no contract enforcement mechanism in international 
staple food grain transactions.

Contracts in organized commodity exchanges are enforced because there is a clear-
ing house which is responsible for making sure that all transactions are executed. Simi-
larly contracts within one national legal jurisdiction can be enforced as there is a legal 
system to ensure contract enforcement, albeit a court based legal enforcement system is 
quite slow. Most international contracts are very similar to Over the Counter (OTC) con-
tracts in the sense that is it only the financial and reputation status of the two parties that 
instills confidence in contract enforcement. There is no mechanism for international con-
tract enforcement, and whatever juridical procedures exist are slow, uncertain, and costly, 
and cannot deal with the immediate risk of contract cancellation.

The basic missing institution is an international contract together with an internation-
al clearing house type of arrangement similar to the clearing houses that are integral parts 
of the organized commodity exchanges, which ensure that all contracts are executed. The 
key question is whether an international contract along with a clearing type of mechanism 
can be envisioned to ensure the performance of staple food type of import contracts. A 
proposal for an international grain contract has been made by Berg (2011b), while Sarris 
(2009) proposed the institution of an International Grain Clearing Arrangement (IGCA). 
These are complementary proposals, as they aim at the same objective namely global con-
tract enforcement. The objective of an IGCA would be to guarantee or insure performance 
of grain import trade contracts (short, medium and long term) between countries or pri-
vate entities based in different countries.

A major function of a commodity exchange clearing house, apart from the settle-
ment of the financial contracts, which amount to the bulk of settlements, is to ensure that 
physical delivery can take place, if needed. This is for instance one of the functions of 
the Chicago Mercantile Exchange (formerly the Chicago Board of Trade), and to ensure 
this a variety of rules and regulations with respect to delivery obligations are adopted by 
the exchange and the clearing house. In most organized exchanges physical delivery is a 
very small portion of all transactions, but if a trader insists on delivery then this must be 
arranged by the exchange. Many exchanges have arrangements with warehouses so that 
physical deliveries can be made against a futures contract, and there are severe penalties 
for anyone with an open contract who either does not fulfill the financial terms or does 
not deliver a physical commodity on it. It is these properties that would need to be emu-
lated by an envisioned international contract and a IGCA, in order to it to be viable as a 
guarantee institution in international staple food transactions.

A global contract, according to Berg, (2011) rather than tracking prices in one geo-
graphical region, would track “cheapest to deliver” commodities, by designating delivery 
points in several places in the world. The traders who could deliver on such a contract 
would be those with relatively low prices. 

There are precedents to this type of global contract, namely the global sugar futures 
contracts of the Intercontinental Exchange and the Euronext Liffe. In these cases the ports 
able to provide the cheapest sugar are the first to deliver against the contract. This provides 
a global signaling system of both price and regional availabilities of sugar ready to export. 
Given that the contracts are provided through organized international exchanges, the deliv-
ery on a given contract is guaranteed through the clearing houses of the relevant exchange. 



229Food commodity price volatility and food insecurity

The only potential drawback is the logistical difficulty of having the supplies delivered in 
some part of the world, which maybe unknown at the time of contracting, and different 
from the location of the desired place of delivery. However, it would not be difficult to 
envision that transport services would be readily available in all major delivery points. 

If a global contract is not instituted by an international exchange then the next best 
way to implement something on an international scale resembling the functions of an 
international contract and the clearing house of existing organized exchanges would be to 
link existing or envisioned commodity exchanges, with their respective clearing houses, or 
to have international exchanges list contracts with several international points of delivery. 
In other words, it maybe appropriate to think of how parts of contracts bought in on one 
exchange could be guaranteed not only by the clearing house of the exchange in question 
but by clearing houses of other linked exchanges. 

The problem is that delivery at a recognized warehouse, e.g. near Chicago where the 
CME delivery locations are, may not be what the importer wants, and may need to incur 
considerable cost to transport those amounts to his desired import location. Hence what 
would be desirable is to have the possibility of taking delivery of the same amount of 
grain but at a location much closer to the importer’s desired destination. One way to do 
this would be to establish links between various commodity exchanges around the world, 
so that the price difference between grain stocks in different locations would be equal to 
the relevant cost of transport and other transactions charges.

The IGCA could be envisioned as a branch of the linked commodity exchanges which 
would in essence consist of some parts of the underlying clearing houses of the exchang-
es. The IGCA would try to guarantee that physical supplies around the world at various 
exchanges are available to execute the international contracts in its member exchanges. 
This could be done, for instance, if part of the financial reserves of the clearing hous-
es that are members of the IGCA could be transformed into a physical reserve, via for 
instance holding warehouse receipts in various reliable locations around the world. The 
advantage of transforming part of the financial reserves into physical reserves would be 
two fold. First, the value of the underlying reserves would fluctuate with the price of the 
underlying commodity. This is like marking the underlying assets to market. This would 
obviate the need by contracting parties to post additional margins in case the price of the 
commodity increases suddenly. 

Second, and this is perhaps a major positive aspect, if some of the financial reserves 
of the IGCA were to be transformed into warehouse receipts, the physical execution of the 
underlying contracts, and not only their financial settlement, could be guaranteed. The com-
mitments in futures or warehouse receipts of the IGCA could be liquidated once the actual 
deliveries on the relevant contract were executed. The liquidation of the physical positions or 
futures holdings of the IGCA would provide the funds to return to the contracting parties 
their posted insurance margins. In fact, since the liquidation of the IGCA margins would 
result in a variable amount as prices fluctuate on the underlying warehouse receipts or 
futures contracts, the restitution to the contracting parties of their initial margins would be 
variable and close to a fixed share (minus some transactions cost) of the underlying transac-
tion value. Hence the true cost to the two parties to an international contract would be the 
interest foregone or paid for the posted good faith margin. Given all the other transactions 
costs in an international staple food import contract this may not be too high.



230 A. Sarris

The IGCA would guarantee the execution of contracts by pooling the resources of sev-
eral exchange related clearing houses. This would ensure that there would be liquidity in 
terms of physical reserves to honor individual contracts in case of non-performance by a 
participant. In fact, the major underlying benefit of the IGCA would be that by investing a 
small part of its reserves into physical warehouse receipts or deliverable futures contracts, 
it would create a global physical commodity reserve stock that could be utilized to execute 
international staple food contracts in case of non-performance of the exporting party to a 
transaction. The major difference, however, of such a stock and stocks envisioned in pre-
vious discussions on global price stabilization would be that this reserve stock would be 
used only to make the market work, namely ensure physical delivery and not to change 
the fundamentals of the market, as most of the other stock holding ideas envision. In the 
words, the stocks held in the form of warehouse receipts or other physically executable 
contracts, would perform the function normally done by so-called pipeline stocks, which 
are held by various market participants to ensure that there is uninterrupted performance 
of the normal market functions of the agent. Their function would not be to stabilize or 
speculate, but simply to ensure liquidity in the market, much as the financial reserves of the 
commodity clearing houses ensure liquidity to execute all underlying financial contracts. 
The necessity for an international arrangement to have such stocks is that there is no such 
physical liquidity mechanism internationally. In other words one of the main functions of 
the IGCA would be to ensure global physical grain liquidity. The IGCA could spread the 
risk of non-performance or country problems by holding its commodity reserves in several 
geographic locations, as well as several organized exchanges.

A major risk of such a IGCA would be that a sovereign country in whose territory, 
the warehouses of the underlying stocks in which the IGCA has invested are physically 
located, could impose export restrictions or bans that may make the physical release of 
stocks impossible. Here, however, is where appropriate export related disciplines could be 
formulated in the context of the World Trade Organization (WTO), or another region-
al arrangement, to prevent exactly this type of phenomenon, as discussed above. Also 
if major IFIs, such as the World Bank, the IMF, and other IFIs are financiers of such a 
IGCA, then the type of sovereign type of default could be guaranteed by these IFIs, per-
haps in the same manner they provide sovereign guarantees and insurance for other 
investment projects. In other words, default on any of the contracts insured with the 
IGCA would entail default with the IFIs behind it, and this may make it harder to default. 
On the downside, the relevant IFIs may be required to devote part of their sovereign guar-
antee capacity to this.

Another major risk of the IGCA maybe the possibility of default by a party. This does 
not have to be only a supplier (in case for instance of increased prices), but could also 
be the buyer (in case of suddenly decreased prices), who may not be interested in a con-
tract at some prices that may now be considered too high. In such a case the seller would 
be losing a portion of the value of the contract due to the decrease in price. Given that 
the IGCA would be an extended arrangement among viable commodity clearing houses, 
it could compensate the seller by the difference in the original and current value of the 
contract insured through the relevant exchange or clearing house.

An essential element then of the proposed IGCA is the internationalization and link-
age of commodity exchanges. This implies that the additional performance guarantees that 



231Food commodity price volatility and food insecurity

are envisioned here can be obtained if two conditions exist. First appropriate exchang-
es must exist in different geographic locations around the world. Such locations should 
most likely be near the major production areas for the commodity in question. Second 
most importers of the food commodity would hedge their subsequent purchases in such 
exchanges. This can become part of most food importers trading practices, and it probably 
is already a practice by many importers. The existence of more exchanges would probably 
reduce the basis risks and hence make trade more efficient.

Clearly this idea needs more thinking and analysis as there are many details that need 
to be elaborated. This could be done by a group of knowledgeable market analysts, but if 
implemented it could go some way to instill more confidence in global food commodity 
markets. 

Market based approaches to managing market volatility 

The idea of this approach is to utilize existing market instruments to anticipate food 
price spikes and insure against their adverse consequences. The major way to do this is via 
futures and options contracts or similar “over the counter” (OTC) instruments. The prob-
lem to deal with is whether the use of organized or OTC futures and options markets can 
reduce the unpredictability of the food import bill, and at what cost. 

Consider an agent who needs to plan imports of some basic food and desires to pro-
tect himself against a price spike. By buying a futures contract or a call option contract 
(namely the right to purchase at a future date an amount of the commodity at a prespeci-
fied strike price), the agent hedges the risk of a price spike, by locking in a maximum 
price for the subsequent transaction. When the subsequent transaction in the cash mar-
ket is executed, the agent can lift the hedge by executing and opposite transaction in the 
futures or option market (namely sell the futures contract or exercise the option contract 
if prices have moved above the strike price), so as to counteract any price variation that 
was not anticipated at the time of planning4. While, on average this type of hedge will not 
make or lose money, there will be a significant reduction in the conditional volatility of 
both price and subsequent purchases. The major advantage to the hedger is that the sub-
sequent price for the transaction is known much better than if the agent waited until the 
time the supplies need to be ordered. In other words predictability is enhanced. 

Sarris, et. al. (2011) as well as Dana, et. al. (2006) have examined in detail cases of 
food importers using futures and options in organized markets and have shown that 
indeed there are substantial reductions in upredictability. 

A drawback of using these types of instruments in a developing country context is 
that credit requirements arising from the need to manage on a daily basis the exchange 
margin calls (in the case of futures), may run up against credit constraints. Another 
drawback is that if the futures market moves in an opposite direction from the one that 
the hedge anticipated, the agent (which could be a government agency) may have to lose 
money, which may be unacceptable to the financing authorities. Call options lessen these 
problems as they basically act as price insurance, by allowing an agent to lock a maxi-

4 The hedge will be affected by “basis risk”, namely the imperfect correlation between the border price of the 
country where the agent operates, and the price at the exchange where the hedge is placed. 



232 A. Sarris

mum price for subsequent imports. The cost is that on average the reduction in unpre-
dictability is smaller than when futures are utilized (Sarris, et. al. 2011). On the other 
hand options are more flexible and with known ex-ante costs. They are also less costly 
than physical stocks. 

Compensatory finance systems

These systems arose in the 1970s and 1980s from the need to assist developing com-
modity exporting countries to deal with sudden drops in export commodity prices. The 
main ones that have been instituted are the IMF Compensatory Financing Facility (CFF), 
and the European Union’s STABEX, which was replaced by the FLEX. 

The IMF’s CFF (for more extensive recent discussions see Gilbert and Tabova, 2011, 
and Konandreas, 2011) was created in 1963 and the cereal import element was added in 
1981, following the food crisis of 1973-75. Its primary purpose was to help IMF members 
cope with temporary export shortfalls and high cereal import costs which create balance 
of payments problems. IMF arrangements and conditionalities applied to such borrowing. 
The main benefit to the countries that used it was an additional IMF window. However, 
while the trigger for disbursements was tied to commodity prices, the schedule for repay-
ments was not tied to export recovery or import cost declines. This tended to undermine 
its unique function. Strict eligibility requirements and costly financial terms led to it not 
being used very much by countries, and it was officially abolished in 2009. A smaller IMF 
scheme named the “Exogenous Shock Facility” (ESF) was established in 2006 to provide 
quick and easy access to concessional financing for low income countries facing exoge-
nous shocks such as food commodity price spikes, natural disasters, or other exogenous 
crises. Conditionalities under this scheme are restricted to measures needed to adjust to 
the shock. The system is currently active. 

The EU’s STABEX was active between 1975 and 2000 as part of the Conventions 
signed between the EU and its former colonies in the Asian Caribbean and Pacific (the 
ACP countries), many of which were dependent of commodities for the bulk of their 
external income. The idea was to compensate the governments of the ACP countries, on 
a grant basis, for export income shortfalls due to variations in export prices or export 
quantities. The funds were given, ex-post to the governments, which used them during 
early periods in a flexible way as balance of payments support, while later they were tar-
geted mostly to the sector affected by the shock. The compensation was given for earn-
ings shortfalls in individual commodities rather than a group of commodities. There were 
several shortcomings of the STABEX, such as delays in fund disbursements that tended to 
making them procyclical rather than countercyclical, its tendency to not stabilize export 
earnings, and others, that led the EU to replace the scheme in 2000 by the Fluctuations of 
Exports (FLEX) scheme. The FLEX had many of the principles of the STABEX, but was 
designed for faster disbursement, and triggers based on overall export income losses rath-
er that on commodity specific losses. 

The basic problem of all compensatory finance schemes is that they are of necessity 
backward looking, and hence slowly disbursing. This does not help with smoothing of the 
export income fluctuations. Food import bill variations have not been part of the STA-
BEX or FLEX schemes, albeit the balance of payments and other impacts maybe similar. 



233Food commodity price volatility and food insecurity

If, however, they were to be made part of the existing compensatory finance schemes they 
would be plagued by similar problems as the existing instruments. They have been viewed 
by most analysts as additional development assistance tools, rather than commodity risk 
management schemes. 

Safety nets

The idea of a food related safety net is to have a system whereby sudden erosion of 
the capacity of food insecure households or countries to maintain food consumption, 
can be dealt with by rapid access to financial resources and food commodities targeted to 
those most vulnerable to food price spikes. Several developing countries have such quick 
reaction programs, and international assistance could help the affected countries keep the 
cost of such programs reasonably low in times of crisis. An example of such a global safe-
ty net program is the World Bank’s Global Food Crisis Response Program (GFCRP) that 
became operational in 2008. The program aims to reduce the negative impact of high food 
prices on the poor, help countries in the design of policies to mitigate the adverse impacts 
of volatile food prices, and support food producers to enhance productivity and reduce 
vulnerability to future crises. 

The GFCRP envisages safety nets in the form of funds to provide cheap food to tar-
geted poor, and financing and technical assistance to increase agricultural supply. Its 
major advantage is that it is quick disbursing. As of mid-March 2013 , the GFCRP had 
financed operations amounting to 1.56 billion US$ in projects. As of July 2012, World 
Bank emergency response is channeled through the International Development Asso-
ciation (IDA) Crisis Response Window, and the recently approved Immediate Response 
Mechanism. The facility depends considerably on donor support, which has been substan-
tial. The main issue with such programs is their sustainability in the future. The GFFR 
proposed above could be a way to enhance sustainability in a cost effective way.

5. Concluding remarks

The problem of food market volatility and intermittent crises and price spikes, does 
not seem likely to go away in the future, and in fact appears likely to become more acute. 
The most vulnerable countries are those who normally have little part in creating the food 
crisis. If growth opportunities of these countries are not to be stalled by occasional food 
crises, the international community must provide appropriate systems to prevent or man-
age the spikes. The paper has reviewed several facets of the global food market volatility 
problem, and the proposals that have been made to deal with it, and has made proposals 
for what maybe deemed as most cost effective and appropriate policy measures. 

The first major conclusion is that the major problem that creates undue market vol-
atility and price spikes is excessive unpredictability of the market. When the degree of 
unpredictability or uncertainty about the market outcomes becomes large, market agents 
(both public and private) tend to overreact to underlying information, and take destabiliz-
ing actions to hedge possible information gaps. In such cases the markets tend to fail, and 
prices tend to spike. It is these market outcomes, which are rather infrequent, that need to 
be prevented or controlled. 



234 A. Sarris

It was seen that food price spikes are possible to define and monitor. Hence, it seems 
that there can be an empirical base on the basis of which the international community can 
base action. 

It appears that there are several ways to manage (rather than prevent) market vola-
tility and spikes for the benefit of low-income food importing countries, and there have 
been several proposals along these lines. The paper has reviewed all these proposals and 
made some new ones. The ones that seem most cost effective and least distorting of inter-
national markets are those that are market based. Among those, utilizing existing systems 
of commodity risk management, such as futures and options is the easiest, and could be 
enhanced by the support of new exchanges in developing countries as well as technical 
assistance on how to exploit the various instruments available. 

A new proposal for a new system of a Global Financial Food Reserve (GFFR) was 
made, in the form of a fund to finance long positions or food commodities in organized 
exchanges. Such a fund could constitute a dormant virtual physical reserve that could gen-
erate physical and financial resources in times of a spike, so as to benefit highly negatively 
affected developing countries. In other words the GFFR would be a market based glob-
al safety net. Apart from the GFFR, the proposal for a Food Import Financing Facility 
(FIFF) was also deemed cost effective and an appropriate mechanism to ensure the con-
tinuous flow of food imports in times of a spike. 

It was seen that there are ways to guarantee the performance of international food 
import contracts, through the promotion of standardized international food contracts in 
existing international commodity exchanges or the linking of existing exchanges and their 
clearing houses, through an International Grain Clearing Arrangement (IGCA). These 
could be explored further with the collaboration of existing exchanges.

The final set of measures that could be taken involve global safety nets. The GFFR 
proposed in the paper is one form of such a global safety net, and a physical emergency 
reserve to smooth out flows of food aid is another. However, others in the form of perma-
nent funds or technical assistance to help needy countries maintain their local food safety 
nets can also be envisioned. 

In summary it appears that there are quite a few cost effective and non-distorting 
measures and options to lower the probability of food price spikes, and help food import-
ing low-income developing countries to manage the attendant risks. Given that food secu-
rity is of paramount concern to all counties, especially those that are at low levels of food 
intake, it appears that the international community has a major role to play in ensuring 
global food security in a world of growing uncertainty. 

Acknowledgements

An earlier version of this paper was presented at the 2nd AIEAA Conference “Between 
Crisis and Development: which Role for the Bio-Economy”, 6-7 June, 2013, Parma, Italy. 

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