The Theoretical Effects of Farm Policies on Optimal Leverage and the Probability of Equity Losses

The degree to which the use of debt is increased in response to risk‐reducing and income‐augmenting farm policies is studied theoretically. A mean‐variance model is used to determine the optimal leverage adjustment, then the effects of policies on the cumulative probability of earning very low rates of return on equity are examined. The evidence suggests that farm policies induce a large enough increase in financial leverage to increase the probability of farmers having negative returns to equity.