Risk Preferences and Environmental Uncertainty: Implications for Crop Diversification Decisions in Ethiopia

To the extent that diversifying income portfolio is used as a strategy for shielding against production risk, both individual risk preferences and weather uncertainty could affect crop diversification decisions. This paper is concerned with empirically assessing the effects of risk preferences and rainfall variability on farm level diversity. Unique panel data from Ethiopia consisting of experimentally generated risk preference measures combined with rainfall data are employed in the analysis. The major contribution of this study is its explicit treatment of individual risk preferences in the decision to diversify, simultaneously controlling for environmental risk in the form of rainfall variability. Covariate shocks from rainfall variability are found to positively contribute to an increased level of diversity with individual risk aversion having a positive but less significant role. We find that rainfall variability in spring has a greater effect than rainfall variability summer—the major rainy season. This finding is in line with similar agronomic-meteorological studies. These results imply that in situ biodiversity conservation could be effective in areas with high rainfall variability. However, reduction in risk aversion, which is associated with poverty reduction, is likely to reduce in situ conservation.