Abstract
Risk management tools are at the core of farm policy in many developed countries, and their effectiveness relies on the appropriate mechanism design. This study developed a gain-loss framework based on prospect theory to examine the reasons for the declining use of the main risk management tool offered to farmers despite growing volatility in returns. Using the administrative Ontario Farm Income Database (OFID) 2003 to 2013 and taking the beef sector as the example, this study found that the gain-loss framework predicts and explains the dynamic program participation pattern better than the conventional expected utility framework. Farms were found to be more likely to stay enrolled in the program when they experienced either larger gains or losses in revenue compared to previous years, suggesting that they were using the insurance programs both as an investment strategy (to seek government subsidies) and as a risk management tool (to protect against business risks), though the effects of revenue losses and hence risk management needs were stronger than gains. In addition, the program payment history and farm characteristics also shape the dynamic participation patterns. The findings increased the understanding of the drivers of withdrawal behavior associated with government-sponsored business risk management programs.
Highlights
Note: Withdrawal defined as participating in AgriStability in time period tÀ1 and not participating in AgriStability in time t
Column 1 of Table 4 (EU) serves as a benchmark and is based on the traditional expected utility theory approach. It shows that the previous year’s program margin decreases a farm entity’s likelihood of withdrawing from the AgriStability program, given the fact that the farm entity participated in the program in the previous year
This study developed a gain-loss framework based on prospect theory to understand the dynamic decisions of farm business enterprises on insurance participation over years
Summary
Note: Withdrawal defined as participating in AgriStability in time period tÀ1 and not participating in AgriStability in time t. The value of participation (or withdrawal) depends on the farm’s program margin in the previous year (Program MargintÀ1), which is calculated as allowable incomes minus allowable expenses. Hypothesis 1 predicts positive value of β1 and θ1. S/he only knows the revenue (or program) margin and changes in the previous year tÀ1 and the exact values of program payment for the years before last year, i.e., tÀ2, tÀ3 and so on. In equation (9), Margin IncreasetÀ1 for a certain farm is defined as the value of margin change if it is positive, and 0 otherwise. Margin DecreasetÀ1 is defined as the value of margin change if it is negative, and 0 otherwise. Equation (10) is different from (9), such that Margin DifferencetÀ1 is defined as the absolute value of margin change, and the dummy indicator I(Margin Increase)tÀ1 equals to 1 if margin changes are positive.
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