The welfare effects of coffee price volatility for Ethiopian coffee producers

This paper estimates the welfare effects for Ethiopian coffee producers from eliminating coffee price volatility. To estimate volatility the GARCH technique is applied to monthly coffee prices in Ethiopia for the period 1976-2012. To distinguish between the unpredictable and predictable components of volatility we obtain separate estimates of the conditional and unconditional variance of the residual. This is combined with estimates of the coefficient of relative risk aversion to measure the welfare effects from eliminating the unpredictable component of price volatility. A key finding is that the welfare gain from eliminating coffee price volatility is small; the gain per producer comes to a meagre US$ 0.76 in a year. This has important policy implications for the efficacy of price stabilisation mechanisms for coffee producers, i.e. any attempt to eliminate coffee price volatility at a cost may not be a preferred outcome for Ethiopian producers. The contribution of the paper lies in using the unconditional variance as it more truly reflects price risk faced by coffee producers without overestimating it.