The Use of Price Elasticity to Estimate Future Volatilities in Stochastic Simulation: an Application to the Korean Rice Market*

Stochastic methods, which random draws on selected exogenous variables of an economic model, generate outcomes for the endogenous variables, are used to capture enough potential outcomes. This stochastic output should reflect historical data in terms of variable levels and variation. Two methods to match historical variation are explored: 1) increasing the variance of error terms of either supply or demand equations causes higher variance in simulated price and quantity, and 2) more elastic demand decreases price variation and increases production variation. A Korean rice market model is used for this stochastic simulation process to test these ideas. The results imply that the elasticities can be used to fit or calibrate model variation to historical variation. The model adjusted by price elasticity provides the possible range of the Aggregate Measurement of Support (AMS). The result shows that there is no possibility of exceeding the total AMS. Our work begins to consider how to improve model performance relating variation, not just levels, thus enabling applied economists using this approach to speak more directly to concerns about market risk and uncertainty. * This study was presented at the annual meeting of the Southern Agricultural Economic Association, February 2-5, 2019, Birmingham, AL, USA ** Research Fellow, Korea Rural Economic Institute, Naju-si, Jeollanam-do, Korea, Corresponding author. e-mail:soonbm@krei.re.kr *** Professor, Food and Agricultural Policy Research Institute, University of Missouri, USA **** Associate Professor, Department of Agricultural Economics, Chungnam National University, Korea ***** Professor, Food and Agricultural Policy Research Institute, University of Missouri, USA 20 Journal of Rural Development 42(Special Issue)