Risk Aversion in Agricultural Policy Analysis: A Closer Look at Meaning, Modeling, and Measurement

Abstract

Estimating participation rates of fanners in voluntary farm programs requires an understanding of farmers’ preferences among alternative probability distributions of income. Traditionally, agricultural economists have assumed that farmers’ utility functions of income completely expressed their risk preferences. In particular, it has been widely believed that risk aversion is equivalent to the concavity of the utility function of income. However, this belief is not entirely accurate. While the equivalence between risk aversion and concavity holds when risk preferences are continuous, the equivalence can fail in one direction and appear to fail in the other direction when risk preferences are discontinuous. In this paper, we describe these results within a mathematically precise framework. In addition, we illustrate how our techniques could be used to measure farmers’ risk responses in the presence of agricultural price supports.