| Abstract: |
"Production systems in low-income developing countries are generally poorly
diversified, focusing on rainfed staple crop production and raising livestock.
These activities are inherently risky and investment and production decisions
by farm households are therefore made within environments that are affected by
risk. Because of poorly developed or absent credit and insurance markets it is
difficult to pass any of these risks to a third party. As a result, it is
often found that even when the expected net return is high, households are
reluctant to adopt new agricultural technologies when they involve risk.
Better understanding risk behavior will be essential for identifying
appropriate farm-level strategies for adaptation to climate change by
low-income farmers. Despite risk's potentially central role in farm investment
decisions, there have been few attempts to estimate the magnitude and nature
of risk aversion of farm households in low-income developing countries. To
partially close this gap, this paper uses an experimental approach applied to
262 households in the Ethiopian highlands with real payoffs. By incorporating
both small and large stakes and gains and losses into the experiment, we test
for the presence of low stake risk aversion and loss aversion. We find that
more than 50 percent of the households are severely or extremely risk averse.
This contrasts with studies in Asia where most household decision-makers
exhibit moderate to intermediate risk aversion. We find that households that
stand to lose as well as gain something from participation in games are
significantly more risk averse than households playing gains-only games. This
strongly suggests that agricultural extension efforts involving losses as well
as gains may face systematic resistance by farmers in low-income, high-risk
environments. Promotion of technologies with downside risks – even if the
upside potential is enormous – should therefore be combined with insurance or
other support. We also find that even without the possibility of losses
households are much more averse to risk when stakes are high. Results indicate
that insurance or other support can likely be phased out. After initial
successes have convinced farmers that technologies are viable, risk aversion
declines. There are also significant differences in risk averting behavior
between relatively poorer and wealthier farm households, which is consistent
with decreasing absolute risk aversion. This suggests that as wealth is built
up households are willing to take on more risk in exchange for higher returns.
Both these findings suggest a strong path dependence. Efforts to develop poor
rural areas through promotion of risky technologies should take this path
dependence into account. Early successes are important, but households should
also be allowed to build up wealth before they are challenged or tempted to
take on more risky ventures. Furthermore, the finding that even without the
possibility of losses households are much more risk averse when stakes are
higher, suggests that agricultural extension should start modestly before
asking households to take on larger gambles." from Authors' Abstract |