Tuesday, 2 October 2012

The mysterious pricing of Bordeaux wines

Ever since the founding of the first commodity exchange in Amsterdam in 1602, there has been an interest at one time or another in everything tradeable - ranging from tulips to grain, and to quality Bordeaux red wines. Hundreds of professionals specialise in the trade, distribution and pricing of these delicacies - yet for a long time, most of their price predictions, based on intuition and tasting, fell short of subsequent results. To this point, this seems like a standard case of price unpredictability - but recently, the research of Orley Ashenfelter, an economist at Princeton has shown that wine prices CAN be predicted. Flabbergasted? Read below, and we will tell you how.

The seemingly unpredictable price of Bordeaux red wine actually is mainly influenced by the weather.
Source: Daily Telegraph

So what is a Bordeaux wine?


Bordeaux is the capital of Aquitaine, a large southwestern French historic and administrational region. For centuries, winemakers used and still use traditional methods to produce some of the world's highest-quality beverage. Tasting of their wines and others has grown into a large and respected industry, with specialists called sommeliers trying to predict future wine prices based on their current taste. In many ways, it's like baseball - a large number of statistic data gets collected, yet results rarely match initial predictions of success. Buyers regularly overpredict price of a new vintage by sometimes a factor of 150%, compared to later prices.
Or at least, that was the case until Ashenfelter's paper in 2008.

Pricing of wines


It is commonly known that wines need to mature years before they reach their best quality - hence the total 'life cycle' of a bottle of wine is quite long, often spanning decades. Compared to this, the twelve months between subsequent grape harvests is quite a short period - nontheless, wines from the same pasture often have value differences by a factor of 10, or even more. Now what could be the only explanation for that, if we assume that the methods of cultivation and the size of fields remains generally constant picking out a single wine producer? The answer is weather.

The wine revolution


While Ashenfelter claims that his results have been known and used for over a decade, it was his paper which became the most known among fellow economists and some wine specialists, generating much debate and controversy. His model shortly states that the price of wines is determined by weather during their production, more specifically three factors: average summer temperature, harvesttime rains, and rainfall during the previous winter. His model correlates with actual prices to a factor of 90%, a very high factor. But why is this the case?

Cold rains, hot summers


The classical model of supply and demand would suggest that wines cost the most when the quantity of them is small - however, this is not the case; in fact, there is little correlation between the two. Another approach would suggest that it is determined by the wine's age - and while there is a correlation, it's still slight.
Rather, wine prices go up when the summers are warm and dry - grapes hence can store more sugar via photosyntesis, and sweeter grapes make for better wines.
This also means that rains during harvesttime are harmful, because the clouds take away precious time from grapes which could otherwise be spent on sweetening. However, some amount of rain is needed - which means that rains during the winter are beneficial for quality grapes, and hence wine.

Market inefficiency


If prices can be so precisely predicted, and the data is widely available, how come that traders didn't find the secret until now? The answer is partially on the supply side. French winemakers wish to have a constant, reliable flow of income - which is directly proportional to the amount of bottles they manage to sell. Hence if the quantity of wine is lower in a given year, they will attempt to raise prices - just like the classical model of supply and demand, and hence this is what most buyers will attempt to follow. However, as we have illustrated, the quality of wine is different from the quantity - hence in the long run, Ashenfelter prevails.

Are you interested further in the topics? Then read Ashenfelter's paper yourself, or ask us in comments.

Sources: O.Ashenfelter: Predicting the Prices and Quality of Bordeaux Wines
                 D.Kahneman: Thinking, Fast and Slow

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