nep-rmg New Economics Papers
on Risk Management
Issue of 2019‒05‒13
28 papers chosen by

  1. IFRS9 Expected Credit Loss Estimation: Advanced Models for Estimating Portfolio Loss and Weighting Scenario Losses By Yang, Bill Huajian; Wu, Biao; Cui, Kaijie; Du, Zunwei; Fei, Glenn
  2. Multi-factor approximation of rough volatility models By Eduardo Abi Jaber; Omar El Euch
  3. Least Impulse Response Estimator for Stress Test Exercises By Christian Gourieroux; Yang Lu
  4. Dependencies and systemic risk in the European insurance sector: Some new evidence based on copula-DCC-GARCH model and selected clustering methods By Anna Denkowska; Stanis{\l}aw Wanat
  5. Do Distressed Banks Really Gamble for Resurrection? By Itzhak Ben-David; Ajay A. Palvia; René M. Stulz
  6. The evolution of the Pillar 2 framework for banks: some thoughts after the financial crisis By Marco Bevilacqua; Francesco Cannata; Raffaele Arturo Cristiano; Simona Gallina; Michele Petronzi; Silvia Cardarelli
  7. Bank Risk Dynamics and Distance to Default By Stefan Nagel; Amiyatosh Purnanandam
  8. Measuring Systemic Risk on Indonesia’s Banking System By Mansur, Alfan
  9. Risk premium in the era of shale oil By Fabrizio Ferriani; Filippo Natoli; Giovanni Veronese; Federica Zeni
  10. A Pareto Criterion on Systemic Risk By Wang, Weijia
  11. Fiscal policy and the assessment of output gaps in real time: An exercise in risk management By Larch, Martin; Cugnasca, Alessandro; Kumps, Diederik; Orseau, Eloïse
  12. Applications of Relaxed Constraint (RC) Models in Portfolio Optimization Subject to VaR, cVaR and Related Risk Constraints By Atwood, Joseph
  13. New Results for Additive and Multiplicative Risk Apportionment By Henri Loubergé; Yannick Malevergne; Béatrice Rey
  14. Overview of Updated and New Crop Risk Management Tools Available to Crop Insurers for the 2019 Crop Year By Borman, Julia; Vergara, Oscar; Desnoyers, Andrew
  15. A closed-form solution to the risk-taking motivation of subordinated debtholders By Heller, Yuval; Peleg Lazar, Sharon; Raviv, Alon
  16. Labor Composite Likelihood Estimation of an Autoregressive Panel Probit Model with Random Effects By Kerem Tuzcuoglu
  17. Market runs of hedge funds during financial crises By Sung, Sangwook; Cho, Hoon; Ryu, Doojin
  18. The Effect of Higher Capital Requirements on Bank Lending: The Capital Surplus Matters By Dominika Kolcunova; Simona Malovana
  19. Roles of Systemic Risk and Premium Subsidies in Choices Between Area and Individual Insurance Contracts By Gong, Xuche; Hennessey, David; Feng, Hongli
  20. Risky Bank Guarantees By Makinen, Taneli; Sarno, Lucio; Zinna, Gabriele
  21. CEO turnover and volatility under long-term employment contracts By Cziraki, Peter; Xu, Moqi
  22. Clawback Provisions and Firm Risk By Babenko, Ilona; Bennett, Benjamin; Bizjak, John M.; Coles, Jeffrey L.; Sandvik, Jason J.
  23. Clarifying the Concept of Price Risk and Volatility, and its Role on Farmers' Decision Making: Application Based on French Milk Market By Randriamarolo, Marie Rose; Lupton, Sylvie
  24. Evaluation of Chinese Agricultural Insurance: The Perspective of Risk Protection By Zhang, Qiao; Wang, Ke; Li, Yue; Zuo, Xuan; Wang, Yueqin
  25. Assessing financial stability risks from the real estate market in Italy: an update By Federica Ciocchetta; Wanda Cornacchia
  26. A looming revolution: Implications of self-generation for the risk exposure of retailers By Russo, Marianna; Bertsch, Valentin
  27. Targeting financial stability: macroprudential or monetary policy? By Aikman, David; Giese, Julia; Kapadia, Sujit; McLeay, Michael
  28. Determinants of Crop Diversification in Burkina Faso - What is the Impact of Risk Preference? By Kotchikpa Gabriel Lawin; Lota Dabio Tamini

  1. By: Yang, Bill Huajian; Wu, Biao; Cui, Kaijie; Du, Zunwei; Fei, Glenn
    Abstract: Estimation of portfolio expected credit loss is required for IFRS9 regulatory purposes. It starts with the estimation of scenario loss at loan level, and then aggregated and summed up by scenario probability weights to obtain portfolio expected loss. This estimated loss can vary significantly, depending on the levels of loss severity generated by the IFSR9 models, and the probability weights chosen. There is a need for a quantitative approach for determining the weights for scenario losses. In this paper, we propose a model to estimate the expected portfolio losses brought by recession risk, and a quantitative approach for determining the scenario weights. The model and approach are validated by an empirical example, where we stress portfolio expected loss by recession risk, and calculate the scenario weights accordingly.
    Keywords: Scenario weight, stressed expected credit loss, loss severity, recession probability, Vasicek distribution, probit mixed model
    JEL: C02 C1 C10 C13 C18 C22 C32 C46 C51 C52 C53 G1 G18 G31 G32 G38
    Date: 2019–04–18
  2. By: Eduardo Abi Jaber (CEREMADE - CEntre de REcherches en MAthématiques de la DEcision - Université Paris-Dauphine - CNRS - Centre National de la Recherche Scientifique); Omar El Euch (X - École polytechnique)
    Abstract: Rough volatility models are very appealing because of their remarkable fit of both historical and implied volatilities. However, due to the non-Markovian and non-semimartingale nature of the volatility process, there is no simple way to simulate efficiently such models, which makes risk management of derivatives an intricate task. In this paper, we design tractable multi-factor stochastic volatility models approximating rough volatility models and enjoying a Markovian structure. Furthermore, we apply our procedure to the specific case of the rough Heston model. This in turn enables us to derive a numerical method for solving fractional Riccati equations appearing in the characteristic function of the log-price in this setting.
    Keywords: limit theorems,affine Volterra processes,Rough volatility models,rough Heston models,stochastic Volterra equations,fractional Riccati equations
    Date: 2019–05–01
  3. By: Christian Gourieroux (CREST - Centre de Recherche en Économie et Statistique - ENSAI - Ecole Nationale de la Statistique et de l'Analyse de l'Information [Bruz] - X - École polytechnique - ENSAE ParisTech - École Nationale de la Statistique et de l'Administration Économique - CNRS - Centre National de la Recherche Scientifique); Yang Lu (CRENAU - Centre de recherche nantais Architectures Urbanités - AAU - Ambiances, Architectures, Urbanités - ECN - École Centrale de Nantes - ENSAG - École nationale supérieure d'architecture de Grenoble - ENSA Nantes - École nationale supérieure d'architecture de Nantes - CNRS - Centre National de la Recherche Scientifique - MCC - Ministère de la Culture et de la Communication)
    Abstract: We introduce new semi-parametric models for the analysis of rates and proportions, such as proportions of default, (expected) loss-given-default and credit conversion factor encountered in credit risk analysis. These models are especially convenient for the stress test exercises demanded in the current prudential regulation. We show that the Least Impulse Response Estimator, which minimizes the estimated effect of a stress, leads to consistent parameter estimates. The new models with their associated estimation method are compared with the other approaches currently proposed in the literature such as the beta and logistic regressions. The approach is illustrated by both simulation experiments and the case study of a retail P2P lending portfolio.
    Keywords: Basel Regulation,Stress Test,(Expected) Loss-Given-Default,Impulse Response,Credit Scoring,Pseudo-Maximum Likelihood,LIR Estimation,Beta Regression,Moebius Transformation
    Date: 2019–04–04
  4. By: Anna Denkowska; Stanis{\l}aw Wanat
    Abstract: The subject of the present article is the study of correlations between large insurance companies and their contribution to systemic risk in the insurance sector. Our main goal is to analyze the conditional structure of the correlation on the European insurance market and to compare systemic risk in different regimes of this market. These regimes are identified by monitoring the weekly rates of returns of eight of the largest insurers (five from Europe and the biggest insurers from the USA, Canada and China) during the period January 2005 to December 2018. To this aim we use statistical clustering methods for time units (weeks) to which we assigned the conditional variances obtained from the estimated copula-DCC-GARCH model. The advantage of such an approach is that there is no need to assume a priori a number of market regimes, since this number has been identified by means of clustering quality validation. In each of the identified market regimes we determined the commonly now used CoVaR systemic risk measure. From the performed analysis we conclude that all the considered insurance companies are positively correlated and this correlation is stronger in times of turbulences on global markets which shows an increased exposure of the European insurance sector to systemic risk during crisis. Moreover, in times of turbulences on global markets the value level of the CoVaR systemic risk index is much higher than in "normal conditions".
    Date: 2019–05
  5. By: Itzhak Ben-David; Ajay A. Palvia; René M. Stulz
    Abstract: We explore the actions of financially distressed banks in two distinct periods that include financial crises (1985-1994, 2005-2014) and differ in bank regulations, especially concerning capital requirements and enforcement. In contrast to the widespread belief that distressed banks gamble for resurrection, we document that distressed banks take actions to reduce leverage and risk, such as reducing asset and loan growth, issuing equity, decreasing dividends, and lowering deposit rates. Despite large differences in regulation between periods, the extent of deleveraging is similar, suggesting that economic forces beyond formal regulations incentivize bank managers to deleverage when their banks are in distress.
    JEL: G11 G21 G33
    Date: 2019–05
  6. By: Marco Bevilacqua (Bank of Italy); Francesco Cannata (Bank of Italy); Raffaele Arturo Cristiano (Bank of Italy); Simona Gallina (Bank of Italy); Michele Petronzi (Bank of Italy); Silvia Cardarelli (Bank of Italy)
    Abstract: This paper examines the evolution of the Pillar 2 framework for banks, introduced by the Basel 2 Accord, and discusses the main issues at stake in the current policy debate. The main objective of Pillar 2 was to complement the minimum requirements established by regulators (Pillar 1) with tailored supervisory measures based on a thorough assessment of banks’ risk profiles. However, its implementation coincided in most jurisdictions with the outbreak of the global financial crisis: the main policy objective became to restore the stability of the global financial system. In this context, Pillar 2 contributed significantly to enhance supervisory action, in particular by raising capital requirements. Nevertheless, a number of issues still remain. Today, in the run-up to the completion of the post-crisis regulatory reform, the debate has regained momentum and a sound supervisory framework can be finalized under more favorable conditions, to avoid that Pillar 2 loses its key properties.
    Keywords: Pillar 2, SREP, Single Supervisory Mechanism, Basel, Stress Test, ICAAP
    JEL: G21 G28
    Date: 2019–04
  7. By: Stefan Nagel; Amiyatosh Purnanandam
    Abstract: We adapt structural models of default risk to take into account the special nature of bank assets. The usual assumption of log-normally distributed asset values is not appropriate for banks. Typical bank assets are risky debt claims, which implies that they embed a short put option on the borrowers’ assets, leading to a concave payoff. This has important consequences for banks’ risk dynamics and distance to default estimation. Due to the payoff non-linearity, bank asset volatility rises following negative shocks to borrower asset values. As a result, standard structural models in which the asset volatility is assumed to be constant can severely understate banks’ default risk in good times when asset values are high. Bank equity payoffs resemble a mezzanine claim rather than a call option. Bank equity return volatility is therefore much more sensitive to big negative shocks to asset values than in standard structural models.
    JEL: G01 G21 G38
    Date: 2019–05
  8. By: Mansur, Alfan
    Abstract: Inter-connectedness is one important aspect of measuring the degree of systemic risk arising in the banking system. In this paper, this aspect together with the degree of commonality and volatility are measured using Principal Component Analysis (PCA), dynamic Granger causality tests and a Markov regime switching model. These measures can be used as leading indicators to detect pressures in the financial system, in particular, the banking system. There is evidence that the inter-connectedness level together with a degree of commonality and volatility among banks escalate substantially during the financial distress. It implies that less systemically important banks could become more important in the financial system during abnormal times. Therefore, the list of systemically important banks regulated in the Law on Prevention and Mitigation of Financial System Crisis (UU PPKSK) should be updated more frequently during the period of financial distress.
    Keywords: Inter-connectedness, systemic risk, Principal Component Analysis, Granger causality, regime switching.
    JEL: C32 C38 G21
    Date: 2018–01–19
  9. By: Fabrizio Ferriani (Bank of Italy); Filippo Natoli (Bank of Italy); Giovanni Veronese (Bank of Italy); Federica Zeni (Bank of Italy)
    Abstract: The boom in the production of shale oil in the United States has triggered a structural transformation of the oil market. We show, both theoretically and empirically, that this process has significant consequences for oil risk premium. We construct a model based on shale producers interacting with financial speculators in the futures market. Compared to conventional oil, shale oil technology is more flexible, but producers have higher risk aversion and face additional costs due to their reliance on external finance. Our model helps to explain the observed pattern of aggregate hedging by US oil companies in the last decade. The empirical analysis shows that the hedging pressure of shale producers has become more important than that of conventional producers in explaining the oil futures risk premium.
    Keywords: shale oil, futures, risk premium, hedging, speculation, limits to arbitrage.
    JEL: G00 G13 G32 Q43
    Date: 2019–04
  10. By: Wang, Weijia
    Abstract: Perfect risk sharing is not an optimal design for financial system because it can increase systemic risk by facilitating risk contagion among financial institutions. However, risk sharing dominates betting according to most Pareto efficiency criteria. One reason for this might be that those Pareto criteria consider individual risk rather than systemic risk and neglect that betting may reduce systemic risk by segmenting the financial system and preventing financial contagion. Refining Pareto criterion to cover systemic risk, I pro- pose the systemic Pareto criterion which has two features: 1) satisfying facts that betting dominates risk sharing when systemic risk is considered. 2) be- ing applicable to scenarios with constant endowment to which current criteria cannot provide compelling suggestions. One implication from this paper is that betting can act as the stabilizer of the economy and prohibiting betting is not always helpful for financial stability.
    Keywords: Risk Sharing, Heterogenous Beliefs, Pareto Efficiency, Systemic Risk
    JEL: D61 D62 G18
    Date: 2019–05–06
  11. By: Larch, Martin; Cugnasca, Alessandro; Kumps, Diederik; Orseau, Eloïse
    Abstract: Fiscal policymakers are expected to conduct countercyclical policies to mitigate cyclical fluctuations of output, but the assessment of cyclical conditions in real time is subject to considerable uncertainty. They face two types of risk: (i) launching discretionary measures to support or dampen aggregate demand when no measures are required (type I error), or (ii) not launching any stabilising measures when this is warranted by cyclical conditions (type II error). A rational policymaker could manage these risks by correcting real-time estimates for past errors, notably the apparent tendency to underestimate good times when they occur. In practice, however, fiscal policy has been largely pro-cyclical or a-cyclical at best. Using statistical decision theory, we calculate thresholds for realtime output gap estimates beyond which governments could launch stabilisation measures, so as to reduce the risk of running pro-cyclical policies. We consider different preferences for avoiding type I or type II errors, and for addressing upside and downside growth risks. We show that the tendency to run pro-cyclical fiscal policy and the ensuing deficit bias can reflect two factors: a preference for activism that is, attaching a lower cost to type I errors, combined with an inclination to be gloomy about cyclical conditions.
    Keywords: fiscal stabilisation,pro-cyclical fiscal policy,risk management,real-time output gap estimates
    JEL: E62 E63 H68
    Date: 2019
  12. By: Atwood, Joseph
    Keywords: Risk and Uncertainty
    Date: 2019–04–05
  13. By: Henri Loubergé (UNIGE - Université de Genève); Yannick Malevergne (PRISM-Sorbonne - PRISM - Pôle de recherche interdisciplinaire en sciences du management - UP1 - Université Panthéon-Sorbonne); Béatrice Rey (GATE Lyon Saint-Étienne - Groupe d'analyse et de théorie économique - ENS Lyon - École normale supérieure - Lyon - UL2 - Université Lumière - Lyon 2 - UCBL - Université Claude Bernard Lyon 1 - Université de Lyon - UJM - Université Jean Monnet [Saint-Étienne] - Université de Lyon - CNRS - Centre National de la Recherche Scientifique)
    Abstract: We start by pointing out a simple property of risk apportionment with additive risks in the general stochastic dominance context defined by Eeckhoudt et al. (2009b). Quite generally, an observed preference for risk apportionment with additive risks in a specific risk environment is preserved when the decision-maker is confronted to other risk situations, so long as the total order of stochastic dominance relationships among pairs of risks remains the same. Our objective is to check whether this simple property also holds for multiplicative risk environments. We show that this is not the case, in general, but that the property holds and more strongly for the case of CRRA utility functions. This is due to a particular feature of CRRA functions that we unveil.
    Keywords: Preserved preference ranking,Multiplicative risks,Constant relative risk aversion,Additive risks,Risk apportionment
    Date: 2019
  14. By: Borman, Julia; Vergara, Oscar; Desnoyers, Andrew
    Keywords: Agricultural and Food Policy, Risk and Uncertainty
    Date: 2019–04–05
  15. By: Heller, Yuval; Peleg Lazar, Sharon; Raviv, Alon
    Abstract: Black and Cox (1976) claim that the value of junior debt is increasing in asset risk when the firm’s value is low. We show, using closed-form solution, that the junior debt’s value is hump-shaped. This has interesting implications for the market-discipline role of banks’ subdebt.
    Keywords: Risk taking, Banks, Asset risk, Leverage, Subordinated debt.
    JEL: G21 G28 G32 G38
    Date: 2019–04–30
  16. By: Kerem Tuzcuoglu
    Abstract: Modeling and estimating persistent discrete data can be challenging. In this paper, we use an autoregressive panel probit model where the autocorrelation in the discrete variable is driven by the autocorrelation in the latent variable. In such a non-linear model, the autocorrelation in an unobserved variable results in an intractable likelihood containing high-dimensional integrals. To tackle this problem, we use composite likelihoods that involve much lower order of integration. However, parameter identification becomes problematic since the information employed in lower dimensional distributions may not be rich enough for identification. Therefore, we characterize types of composite likelihoods that are valid for this model and study conditions under which the parameters can be identified. Moreover, we provide consistency and asymptotic normality results of the pairwise composite likelihood estimator and conduct Monte Carlo simulations to assess its finite-sample performances. Finally, we apply our method to analyze credit ratings. The results indicate a significant improvement in the estimated transition probabilities between rating classes compared with static models.
    Keywords: Credit risk management; Econometric and statistical methods; Economic models
    JEL: C23 C25 C58 G24
    Date: 2019–05
  17. By: Sung, Sangwook; Cho, Hoon; Ryu, Doojin
    Abstract: A hedge fund's capital structure is fragile because uninformed fund investors are highly loss sensitive and easily withdraw capital in response to bad news. Hedge fund managers, sharing common investors and interacting with each other through market price, sensitively react to other funds' investment decisions. In this environment, panic-based market runs can arise not because of systematic risk but because of the fear of runs. The authors find that when the market regime changes from a normal state to a "bad" state (in which runs are possible), hedge funds reduce investment prior to runs. In addition, the market runs are more likely to occur in a market where hedge funds hold greater market exposure and uninformed traders have greater sensitivity to past price movement.
    Keywords: market sustainability,market runs,hedge funds,limits of arbitrage,financial crises,synchronization risk
    JEL: G01 G23
    Date: 2019
  18. By: Dominika Kolcunova; Simona Malovana
    Abstract: This paper studies the impact of higher additional capital requirements on growth in loans to the private sector for banks in the Czech Republic. The empirical results indicate that higher additional capital requirements have a negative effect on loan growth for banks with relatively low capital surpluses. In addition, the results confirm that the relationship between the capital surplus and loan growth is also important at times of stable capital requirements, i.e. it does not serve only as an intermediate channel of higher additional capital requirements.
    Keywords: Bank lending, banks' capital surplus, regulatory capital requirements
    JEL: C22 E32 G21 G28
    Date: 2019–04
  19. By: Gong, Xuche; Hennessey, David; Feng, Hongli
    Keywords: Agricultural and Food Policy, Risk and Uncertainty
    Date: 2019–04–05
  20. By: Makinen, Taneli; Sarno, Lucio; Zinna, Gabriele
    Abstract: Applying standard portfolio-sort techniques to bank asset returns for 15 countries from 2004 to 2018, we uncover a risk premium associated with implicit government guarantees. This risk premium is intimately tied to sovereign risk, suggesting that guaranteed banks, defined as those of particular importance to the national economy, inherit the risk of the guarantor. Indeed, this premium does not exist in safe-haven countries. We rationalize these findings with a model in which implicit government guarantees are risky in the sense that they provide protection that depends on the aggregate state of the economy.
    Keywords: banks; government guarantee; Risk premium; sovereign risk
    JEL: G23
    Date: 2019–05
  21. By: Cziraki, Peter; Xu, Moqi
    Abstract: We study the role of the contractual time horizon of CEOs for CEO turnover and corporate policies. Using hand-collected data on 3,954 fixed-term CEO contracts, we show that remaining time under contract predicts CEO turnover. When contracts are close to expiration, turnover is more likely and is more sensitive to performance. We also show a positive within-CEO relation between remaining time under contract and firm risk. Our results are similar across short and long contracts and are driven neither by firm or CEO survival, nor technological cycles. They are consistent with incentives to take long-term projects with interim volatility.
    Keywords: risk taking; volatility; career concerns; CEO contracts; CEO turnover
    JEL: G34 J41 J63
    Date: 2019–02–27
  22. By: Babenko, Ilona (Arizona State University); Bennett, Benjamin (Ohio State University (OSU) - Department of Finance); Bizjak, John M. (Texas Christian University); Coles, Jeffrey L. (University of Utah - Department of Finance; Arizona State University (ASU) - Finance Department); Sandvik, Jason J. (University of Utah)
    Abstract: Panel OLS and GMM-IV estimates indicate that executives respond to the adoption of a compensation clawback provision by decreasing firm risk. The mechanisms that transmit incentives to decisions and decisions to risk appear to be more conservative investment and financial policies and preemptive management of ESG, legal, and cyberattack risks. The stock market reaction to the announcement of a clawback adoption, as well as post-adoption stock and accounting performance, are significantly and positively related to the actual and predicted reduction in firm risk. The reduction in firm risk, arising from adoption of a clawback policy, appears to benefit shareholders.
    JEL: G32 G34 J33 M41 M52 M55
    Date: 2019–04
  23. By: Randriamarolo, Marie Rose; Lupton, Sylvie
    Keywords: Risk and Uncertainty
    Date: 2019–04–05
  24. By: Zhang, Qiao; Wang, Ke; Li, Yue; Zuo, Xuan; Wang, Yueqin
    Keywords: Agricultural and Food Policy, Risk and Uncertainty
    Date: 2019–04–06
  25. By: Federica Ciocchetta (Bank of Italy); Wanda Cornacchia (Bank of Italy)
    Abstract: We provide an update of the analytical framework to assess financial stability risks arising from the real estate sector in Italy. The enhancement concerns the definition of a new vulnerability indicator, measured in terms of the flow of total non-performing loans (NPLs) and not, as done previously, in terms of bad loans only. We focus separately on households (as an approximation for residential real estate, RRE) and on firms engaged in construction, management and investment services in the real estate sector (as an approximation for commercial real estate, CRE). Two early warning models are estimated using the new vulnerability indicator for RRE and CRE, respectively, as dependent variable. Both models exhibit good forecasting performances: the median predictions fit well the new vulnerability indicators in out-of-sample forecasts. Overall, models’ projections indicate that potential risks for banks stemming from the real estate sector will remain contained in the next few quarters.
    Keywords: real estate markets, early warning models, bayesian model averaging, banking crises
    JEL: C52 E58 G21
    Date: 2019–04
  26. By: Russo, Marianna; Bertsch, Valentin
    Date: 2018
  27. By: Aikman, David; Giese, Julia; Kapadia, Sujit; McLeay, Michael
    Abstract: This paper explores monetary-macroprudential policy interactions in a simple, calibrated New Keynesian model incorporating the possibility of a credit boom precipitating a financial crisis and a loss function reflecting financial stability considerations. Deploying the countercyclical capital buffer (CCyB) improves outcomes significantly relative to when interest rates are the only instrument. The instruments are typically substitutes, with monetary policy loosening when the CCyB tightens. We also examine when the instruments are complements and assess how different shocks, the effective lower bound for monetary policy, market-based finance and a risk-taking channel of monetary policy affect our results. JEL Classification: E52, E58, G01, G28
    Keywords: countercyclical capital buffer, credit boom, financial crises, financial stability, macroprudential policy, monetary policy
    Date: 2019–05
  28. By: Kotchikpa Gabriel Lawin; Lota Dabio Tamini
    Abstract: The literature considers crop diversification to be a risk management strategy at the farm level. In this article, we combine experimental data on risk aversion with survey data to identify the extent to which risk aversion affects crop diversification decisions. We conduct experiments to measure the risk aversion of smallholder farmers in Burkina Faso and a field survey to gather data on various socio-economic variables. To measure crop diversification, we use three indices of spatial diversity in crop species adapted from the ecological economics literature, i.e., the weighted count index, the weighted Herfindahl index measure of crop concentration and the weighted Shannon index of evenness. An Ordinary Least square (OLS) model is used to estimate the impact of risk aversion on crop diversification when the weighted count index and the weighted Herfindahl index are used as the dependent variable, whereas a Tobit model is used for the weighted Shannon index. Our results show that risk aversion has a negative and significant effect on crop diversification. Risk-averse producers focus more on the production of traditional, less risky and low market value crops. Other variables also affect crop diversification. In particular, education level, distance to market, farm area and land fragmentation are associated with greater crop diversification.
    Keywords: Risk aversion,diversity index,crop diversification,smallholder farmers,Burkina Faso,
    JEL: C93 D13 G11 Q12 Q57
    Date: 2019–05–01

General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.