Risk balancing at the household level: Implications for policy and risk management

Abstract

Traditionally, agricultural economists employ farm level modeling for a variety of purposes. Central to these modeling techniques is the behavioral assumption of farm profit maximization, or, when risk preferences are put into play (risk aversion), utility maximization. However, there is abundant literature, from different (sub)disciplines such as farming systems research, rural sociology, rural development and rural economic geography that views farm household activities in the wider economic context (e.g. Gasson et al., 1988, Dries et al., 2011, Bessant, 2006). In such view, farm households are considered pluriactive and may distribute assets between agricultural and non-agricultural purposes to accomplish their goals. Hence, according to this view, a more realistic behavioral assumption than profit maximization at the farm level would be the optimization of farm household risk (i.e. the chance of falling below a certain threshold level of household cash flow). Focusing on farm household level risk is a natural transition from farm-level risk analysis since the largest proportion of farms in the EU are family farms and many farmers already implement risk management strategies at the household level. Although the income maximization assumption is being contested in literature (e.g. Freshwater and Jette-Nantel, 2011) and more concern is being given about the welfare and well-being of households instead of focusing on the level of income (e.g. Boisvert, 2002), to the best of our knowledge, it is very uncommon in the agricultural economics literature on risk analysis to include a measure of household risk or consider the household as the entity of interest. This paper develops a farm household simulation model that describes the potential implications of considering the optimizing of farm household level risk as a behavioral response. It starts from conceptual descriptions of operational -, financial -, farm - and farm household risk. It then models the behavior of a typical dairy farm household as one optimizing farm household risk and derives the implications of alternative risk management strategies.