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Risk aversion in low income countries: Experimental evidence from Ethiopia

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  • Yesuf, Mahmud
  • Bluffstone, Randy

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

Suggested Citation

  • Yesuf, Mahmud & Bluffstone, Randy, 2007. "Risk aversion in low income countries: Experimental evidence from Ethiopia," IFPRI discussion papers 715, International Food Policy Research Institute (IFPRI).
  • Handle: RePEc:fpr:ifprid:715
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    Cited by:

    1. Edward Kato & Claudia Ringler & Mahmud Yesuf & Elizabeth Bryan, 2011. "Soil and water conservation technologies: a buffer against production risk in the face of climate change? Insights from the Nile basin in Ethiopia," Agricultural Economics, International Association of Agricultural Economists, vol. 42(5), pages 593-604, September.
    2. Kassie, Menale & Holden, Stein & Köhlin, Gunnar & Bluffstone, Randy, 2008. "Economics of Soil Conservation Adoption in High-Rainfall Areas of the Ethiopian Highlands," RFF Working Paper Series dp-08-09-efd, Resources for the Future.
    3. De Pinto, Alessandro & Robertson, Richard D. & Obiri, Beatrice Darko, 2013. "Adoption of climate change mitigation practices by risk-averse farmers in the Ashanti Region, Ghana," Ecological Economics, Elsevier, vol. 86(C), pages 47-54.
    4. Akay, Alpaslan & Martinsson, Peter & Medhin, Haileselassie & Trautmann, Stefan T., 2009. "Attitudes toward Uncertainty among the Poor: Evidence from Rural Ethiopia," IZA Discussion Papers 4225, Institute of Labor Economics (IZA).
    5. Wellalage, Nirosha & Locke, Stuart, 2017. "Access to credit by SMEs in South Asia: do women entrepreneurs face discrimination," Research in International Business and Finance, Elsevier, vol. 41(C), pages 336-346.
    6. Birthal, Pratap Singh & Nigam, Shyam N. & Narayanan, A.V. & Kareem, K.A., 2012. "Potential Economic Benefits from Adoption of Improved Drought-tolerant Groundnut in India," Agricultural Economics Research Review, Agricultural Economics Research Association (India), vol. 25(1), June.
    7. Beyene, Abebe D. & Bezabih, Mintewab & Gebreegziabher, Zenebe, 2012. "Contract Duration under Incomplete Land Ownership Rights: Empirical Evidence from Rural Ethiopia," RFF Working Paper Series dp-12-09-efd, Resources for the Future.
    8. Haneishi, Yusuke & Maruyama, Atsushi & Takagaki, Michiko & Kikuchi, Masao, 2014. "Farmers’ risk attitudes to influence the productivity and planting decision: A case of rice and maize cultivation in rural Uganda," African Journal of Agricultural and Resource Economics, African Association of Agricultural Economists, vol. 9(4), pages 1-14, December.
    9. Bernd Hardeweg & Lukas Menkhoff & Hermann Waibel, 2013. "Experimentally Validated Survey Evidence on Individual Risk Attitudes in Rural Thailand," Economic Development and Cultural Change, University of Chicago Press, vol. 61(4), pages 859-888.
    10. Emma Jane Dillon & Thia Hennessy & Peter Howley & John Cullinan & Kevin Heanue & Anthony Cawley, 2018. "Routine inertia and reactionary response in animal health best practice," Agriculture and Human Values, Springer;The Agriculture, Food, & Human Values Society (AFHVS), vol. 35(1), pages 207-221, March.
    11. Diiro, Gracious M. & Ker, Alan P. & San, Abdul G., 2015. "The role of gender in fertiliser adoption in Uganda," African Journal of Agricultural and Resource Economics, African Association of Agricultural Economists, vol. 10(2), pages 1-14.
    12. Farrin, Katie & Miranda, Mario J., 2015. "A heterogeneous agent model of credit-linked index insurance and farm technology adoption," Journal of Development Economics, Elsevier, vol. 116(C), pages 199-211.
    13. Wright, Joshua, 2017. "To what extent does income predict an individual’s risk profile in the UK (2012- 2014)," MPRA Paper 80757, University Library of Munich, Germany.
    14. Ali, Akhter, 2013. "Farmers’ Willingness to Pay for Index Based Crop Insurance in Pakistan: A Case Study on Food and Cash Crops of Rain-fed Areas," Agricultural Economics Research Review, Agricultural Economics Research Association (India), vol. 26(2).
    15. Rijkers, Bob & Söderbom, Måns, 2013. "The Effects of Risk and Shocks on Non-Farm Enterprise Development in Rural Ethiopia," World Development, Elsevier, vol. 45(C), pages 119-136.
    16. Nguyen, Quang, 2009. "Do fishermen have different preferences?: Insights from an experimental study and household data," MPRA Paper 16012, University Library of Munich, Germany.
    17. Mintewab Bezabih, 2009. "Heterogeneous Risk Preferences, Discount Rates and Land Contract Choice in Ethiopia," Journal of Agricultural Economics, Wiley Blackwell, vol. 60(2), pages 402-418, June.
    18. Henk Folmer & Subrata Dutta & Han Oud, 2010. "Determinants of Rural Industrial Entrepreneurship of Farmers in West Bengal: A Structural Equations Approach," International Regional Science Review, , vol. 33(4), pages 367-396, October.
    19. Mintewab Bezabih & Finn Tarp & Hailemariam Teklewold & Alemu Mekonnen & Tagel G/Hiwot, 2023. "Traditional versus improved varieties of seed: Is there a trade-off between productivity and risk?," DERG working paper series 23-21, University of Copenhagen. Department of Economics. Development Economics Research Group (DERG).
    20. Jaime Ruiz-Tagle V. & Pablo Tapia G., 2012. "Brechas por Género en Aversión al Riesgo," Working Papers wp373, University of Chile, Department of Economics.
    21. Cardenas, Juan Camilo & Carpenter, Jeffrey, 2013. "Risk attitudes and economic well-being in Latin America," Journal of Development Economics, Elsevier, vol. 103(C), pages 52-61.
    22. Kato, E., 2009. "Soil and water conservation technologies: a buffer against production risk in the face of climate change?: insights from the Nile Basin in Ethiopia," IWMI Working Papers H042477, International Water Management Institute.
    23. Pamela Katic & Tim Ellis, 2018. "Risk aversion in agricultural water management investments in Northern Ghana: experimental evidence," Agricultural Economics, International Association of Agricultural Economists, vol. 49(5), pages 575-586, September.
    24. Aina, I. & Ayinde, O.E. & Thiam, D. & Miranda, M., 2018. "Willingness to Pay for Index-Based Livestock Insurance: Perspectives from West Africa," 2018 Conference, July 28-August 2, 2018, Vancouver, British Columbia 277383, International Association of Agricultural Economists.
    25. Peter Howley & Emma Dillon & Kevin Heanue & David Meredith, 2017. "Worth the Risk? The Behavioural Path to Well-Being," Journal of Agricultural Economics, Wiley Blackwell, vol. 68(2), pages 534-552, June.

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    Keywords

    experimental studies; loss aversion; risk aversion; Risk management; econometric models; Farm households;
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