RISK PREFERENCES UNDER PRICE UNCERTAINTIES AND PRODUCTION RISK

Abstract

This paper deals with estimation of risk preferences of producers when they face uncertainties in output and input prices, in addition to uncertainty in production (usually labeled as production risk). All these uncertainty components are modeled in the context of production theory where the producers maximize expected utility of anticipated profit. Risk preference functions associated with these uncertainties are derived without assuming a specific form of the utility function. Moreover, no distributional assumptions are made on the distributions of the random variables representing price and production uncertainties. A multi-stage estimation procedure is developed to estimate the parameters of the production function and risk preference functions associated with output price uncertainty, input price uncertainty and production risk. Production risk is specified in such a way that one can identify inputs with increasing, decreasing and constant production risks. Similarly, risk aversion behavior is specified in such a way that one can test for different types of risk aversion behavior.