Adverse Shocks in Agriculture: The Assessment and Management of Downside Risk

This paper investigates the assessment and effects of adverse shocks on agricultural production, with an application to corn yield. Adverse shocks are assessed by the probability of facing low yields, i.e. by the probability of being exposed to downside risk. Defined in terms of willingness‐to‐pay to eliminate risk, the ex‐ante cost of facing adverse events is evaluated under prospect theory. Prospect theory is relevant in the evaluation of adverse shocks as it identifies a role for both loss aversion and oversensitivity to low probability events. The analysis is applied to experimental data on corn yield in the US Corn Belt. Estimates show how the distribution of corn yield is affected by management and technology. Implications for the cost of adverse shocks are examined. The results show how management and technology can reduce exposure to adverse shocks and lower the cost of risk in agriculture.