Production Function and Farmers’ Risk Aversion: A Certainty Equivalent-adjusted Production Function

Abstract

Faced with risky yields and returns, risk-averse farmers require a premium to take risks. In this paper, we estimate individual farmers’ degrees of risk aversion to adjust for the risk premium in returns and to replace the farmers’ realized returns with their certainty equivalent returns in the production function. In that way, the effect of the inputs on returns will automatically be risk-adjusted, i.e., we obtain risk-adjusted marginal effects of inputs, which can be used in decision-making support of farmers’ input choices in production. Using farm-level data from organic basmati rice smallholders in India, we illustrate this method using nonparametric production functions. The results show that the input elasticities and returns-to-scale estimates change when the farmers’ degree of risk aversion is taken into consideration.