Elements of Risk and Uncertainty
in Agriculture
Presented by
Gourav Kumar Vani
29-07-2017
1
Acknowledgment
• I acknowledge that the basic material for this
presentation has been derived from the
previous presentations of Bhavya H.K. (M.Sc.
Agri Econ 2012-14,UAS, Bangalore)
and
Prof. dr. ir. Guido Van Huylenbroeck,
Department of Bio-Science Engineering, Ghent
university.
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2
Concept of Risk and Uncertainty
Risk:
– Possibility of loss or injury [in layman’s language]
– A situation when all possible outcomes are known
for a given management decision and
probability associated with each outcome is
known(S. SubbaReddy et al.,2004).
– Situations where parameters of the probability
distribution of outcomes can be empirically
estimated.(Palanisami, Paramasivam and
Ranganathan, 2002)
– “risk is uncertainty that matters” (Harwood et al.,
1999)
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Continued…
• A decision is said to be risky when the precise outcome is
not known at the time the decision must be taken.
• Risk is associated with future events,
which has not happened yet.
• Issue: A risk which has already occurred is considered as
issue.
• Opportunities: +ve risks are called Opportunities. You
would like to take maximum advantage of these positive
risks.
• Risk Appetite: Amount and type of risk that an organization
is prepared to seek, accept or tolerate.
• Risk Tolerance: Organization’s readiness to bear the risk
treatments in order to achieve its objectives.
• Risk is not inherently bad because risk is associated
with profits.
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4
Continued…
• Generally more risk leads to more reward, But
that is not always true
-you want more rewards with less risk.
• Risks are unavoidable, but they are manageable.
At the best Enterprise carrying the risk can
be avoided.
• Since function of entrepreneur is to take risk and
farmer is an Agripreneur, therefore
he/she has to take risk.
• A farmer must take calculated risk.
A situation of taking risk beyond capacity
to bear it or counter it leads to crisis.
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Continued…
Uncertainty:
– no idea of probability
– Those situations in which the parameters of the
probability distribution of outcomes can not be
empirically estimated . (Palanisami, Paramasivam
and Ranganathan, 2002)
– Imperfect Knowledge (Hardaker)
If a farmer is aware of the fact that he may not get
irrigation water once in three years, then it refers the risk;
whereas if he is not aware of the fact that he will get
water in any particular year or not, then it refers to
uncertainty.
(Palanisami,
Paramasivam
and
Ranganathan, 2002)
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Risk-Benefit Analysis
Crop production for
subsistence, less
external inputs or land
leased out for fixed rent
or crop sharing
Benefit
Taking calculated risk
within the tolerable
limit, cash crops,
commercial farming
Low Risk
No production and
only fixed costs are
incurred.
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High Risk
Taking risk beyond
capacity
Loss
Note: This analysis is product of presenters’ intuition and does not find
any place in the already published material.
7
Optimum Input Use under Risk
Cost
The input use with risk is always below the optimum level
under no risk conditions. This is due to the fact that most of the
farmers are risk averters.
Marginal revenue
Risk adjusted
marginal revenue
Marginal cost =Px
X1
X0
Input
Source: (Palanisami, Paramasivam and Ranganathan, 2002)
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•The difference between the riskless and risk case is that in the
former , the objective is to maximize the profits and in the
latter the objective is maximization of utility.
•In the profit maximization case, the former is interested to use
the inputs as long as VMP=Price of input (Pxi), whereas in the
expected utility maximization case, he uses inputs as long as
expected value of the marginal product, E(VMP)=Cost of input.
•The cost of input here has two components, viz., direct
(marginal) cost(Pxi) and cost of risk, due to risk aversion
attitude of the farmer. In case of risk, input use was reduced
because of the increased cost associated with the risk.
Source: (Palanisami, Paramasivam and Ranganathan, 2002)
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Why Risk Arises in Agriculture ?
•
•
•
•
Dependence on Nature (Production Risk)
Human Elements (Human/Personal Risk)
Markets (Price Risk/Market risk)
Government rules and regulations
(Institutional Risk)
• Financial Matters (Financial Risk)
Source: Hardakar,2004
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Production Risk
• Insect-Pest Attack (Both crop and livestock)
• Weather dependence (esp. rain/drought )
• Weather phenomenon like Hurricane,
hailstorms, acid rain, fog etc.
• Breakage/non-functioning of farm machinery
at crucial time
• Fire on the farm may destroy crop
Source: Hardakar,2004
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Human/Personal Risk
• Those who operate the farm becomes a
source of risk to the profitability of the farm.
• Prolonged illness/death/non-availability of
labourer/key management employee, labour
strike.
• Disputes at farm or within farming family
leading to disruption of farm work (Divorce).
Source: Hardakar,2004
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Price/Market Risk
• Changes taking place in market (both input
and output) becomes source of risk for farmer.
• Fluctuations in prices and availability of inputs
like labour, seeds, fertilizers, plant protection
chemicals, plant growth promoters etc.
• Volatility in output prices of both main and
bye product.
Source: Hardakar,2004
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Institutional Risk
• Changes in Government rules and regulation or
policy orientation becomes a source of risk.
• Ban on export of some commodities (like onion),
• Restricting movement of agricultural produce,
• Imposing levy on some commodities,
• Acreage restriction, quantitative restrictions
• Ban on production in some region
• Restriction on resource utilization (for conserving
ground water),
• Subsidy and taxation changes, etc.
Source: Hardakar,2004
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Institutional Risk Continued…
• Infrastructural barriers limits the ability of the
entrepreneurs to profit.
• For example: If good road facility is not present
then a perishable commodity of however good
quality will deteriorate at farm gate and would
lead to massive losses to producer.
• Such gaps in infrastructure must be bridged by
the respective governments because it is a public
good. Thus public funding plays a vital role in risk
reduction.
• Similar is the case of technological barriers.
Source: Hardakar,2004
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Financial Risk
• Risk also arises from the changes taking place
in financial markets. This type of risk is not
considered either in Market risk or
Institutional risk due to its unique character.
• Institutions also include financial institutions
but farmers borrows from no-institutional
sources. Also financial institutions are part of
financial markets but are also part of
institutional arrangements.
Source: Hardakar,2004
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Financial Risk
• Such risk arises because of
 Changes in rate of interest
 Changes in institutional policy regarding
lending to a particular crop/enterprise.
 Changes in repayment plans drawn by the
banks.
 Non-institutional lenders forces to make
repayment in kind than cash.
Source: Hardakar,2004
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Business Risk
• The aggregate effect of production, personal,
market and institutional risk is called Business
risk.
• Business risk is the risk facing the firm
independent of the way in which it is
financed. Hence financial risk is not part of it.
• It is aggregate effect of all the uncertainty
influencing the probability of the firm.
Source: Hardakar,2004
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Uncertainty in Agriculture
• A good example of it can be the outbreak of
Avian-bird flu leading to massive losses to
poultry farmers.
• Though a disease is insurable but when such
disease are totally new to the world and
outbreak happens suddenly then insurance
agency do not pay for such damage because
insurance agencies insure only for known and
existing diseases not for the unknown one.
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Uncertainty in Agriculture
• Another such example can be the case of Mad cow
disease(Bovine spongiform encephalopathy, BSE) when
the disease outbreak happened in England (1984).
• Melamine contamination in milk from China (2008)
was not thought off by any agency or farmer. After it
was found then EU banned milk import from China and
prices of milk crashed in China thereafter.
• Technological uncertainty occurs when the new
technology the farmers adopt do not respond in their
locations.
(Palanisami,
Paramasivam
and
Ranganathan, 2002)
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Measurement of Risk
Measuring risk makes it possible to establish the
institutions and protective mechanisms for
mitigation.
Risk = Possibility x consequence x exposure
Probabilities can be attached to each event that
can occur in a risky environment.
Consequence of each event must be known to us.
Consequence can be either loss or benefit.
Exposure is the magnitude of loss/benefit that is
likely to accrue to the firm.
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Methods of Risk Tolerating
1. Retain – take the risk - push the envelope;
make no protective arrangements (as in holding
an un-priced commodity);
2. Shift – sell if off/Insurance – Usually the one
who holds the commodity bears the risk. Hence it
is better to dispose of the commodity at the
earliest. But disposing it off at throw away price
would be a distress sale. Hence a person can go
for insurance. Even contract farming would shift
part of the risk on to the contractor.
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Methods of Risk Tolerating
3.Reduce – prevention is better- so using good
practices, such as,
 intercropping (Diversification)
 irrigation (Ex. instead of rain-fed production),
selecting resistant varieties (Ex. drought, pest,
disease,) or
securing marketing contracts to assure some
guarantee of sales.
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Methods of Risk Tolerating
4. Self-insure – save for the rainy day – by
keeping emergency reserves (contingency
funds) from funded from previous years’
profits to mitigate losses without burden a
high premium.
5. Avoid – play it safe – by not selecting a
particular enterprise; not pushing either end
of planting windows; not increasing debt-to
asset ratio beyond your comfort level.
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What is Risk Management?
• Risk management is the identification,
assessment, and prioritization of risk(positive
or negative) followed by coordinated and
economical application of resources to
minimize, monitor, and control the probability
and/or impact of unfortunate events or to
maximize the realization of opportunities.
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.
What is Risk Management?
Minimize
Identification of Risks
Monitor
Assessment of
Risks
Prioritization of
Risks
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Control
Resources
Probability and/or Impact
of Unfortunate Events
Maximize
Realization of Opportunities
26
Risk Management in Agriculture
“In today’s environment, opportunities have
increased, but so have the risks. Risk
management must become a key element of the
‘new’ agriculture. Risk management means
engaging in agriculture with confidence in a
rapidly changing world.”
• Effective risk management involves anticipating
possible difficulties and planning to reduce their
consequences. Effective risk management is not
about reacting to unfavorable events after they
occur.
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Risk Management Steps
Plan Risk
Management
Indentify
Risks
Analyze Risk
Monitor and
control Risks
Plan Risk
Response
Risk management plan specifies the management intent,
systems and procedure required for managing risks.
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1. Plan Risk Management
Risk management plan will provide the definitions of various risk related
terms. It also sets roles and responsibilities and tools for assessment of
the risks. It also includes steps on as to how to execute the plan.
2. Identification of Risks
• Risk identification is systematic and methodic process.
• It is best done in group environment.
• Wide no. of people participate in this process including –
management, employees, customers and other stake holders.
• Tools used for risk identification are
i.
Brainstorming (most common approach)
ii. Ishikawa Diagrams (cause and effect)
iii. Flow Diagram
iv. SWOT Diagram (Strengths, Weakness, Opportunities and
Threats)
•
Risk Register: Output of risk identification process is a risk register.
•
This list down all the risks identified.
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Ishikawa diagrams
Ishikawa diagrams (also called fishbone
diagrams, herringbone diagrams, cause-andeffect diagrams, or Fishikawa) are causal
diagrams created by Kaoru Ishikawa (1968) that
show the causes of a specific event. Common
uses of the Ishikawa diagram are product design
and quality defect prevention to identify
potential factors causing an overall effect. Each
cause or reason for imperfection is a source of
variation. Causes are usually grouped into major
categories to identify these sources of variation.
29-07-2017
Source: Wikipedia
30
Source:https://www.google.co.in/search?q=ishikawa+diagram&source=lnms&tbm=isch&s
a=X&ved=0CAcQ_AUoAWoVChMIqN_5n6ehyAIVRI6OCh3fNQma&biw=1093&bih=502#tb
m=isch&q=ishikawa+diagram+for+farmer&imgrc=4VJf8upMGu1PAM%3A
29-07-2017
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Source:
https://www.google.co.in/url?sa=i&rct=j&q=&esrc=s&source=images&cd=&cad=rja&uact=8&ved=0CA
YQjB1qFQoTCNev9dynocgCFYe3jgodjSEGcA&url=http%3A%2F%2Fwww.vertex42.com%2FExcelTempla
tes%2Ffishbonediagram.html&bvm=bv.104226188,d.c2E&psig=AFQjCNFFaeqOHr8Rh9CGq5XV72_uCHhq8w&ust=144
3790091998691
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3. Analyze Risks
•This is the process of quantifying risk.
•Risks are analyzed to set priority.
•Set focus on high priority risk.
Qualitative Risk Analysis
Qualitative Risk Analysis
Quick and Easy to
perform
Subjective
Probability and Impact
Matrix
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Detailed and time
consuming
Analytical
Standard Deviation, C.V.,
Expected Monitory value
(EMV) Analysis, Monte
Carlo Analysis , Decision
Tree Analysis, Payoff
Matrix, Decision rules
33
Probability and Impact Matrix
This is a qualitative risk analysis tool.
This evaluates
Likelihood (probability) that a particular risk will occur.
Potential impact on objective if it occurs.
Each risk is analyzed for probability and impact and is assigned
•a nine point rating : a score between 1 to 9.
•a five point rating : a score between 1 to 5 (very low, low, medium,
high, very high).
•a three point rating : a score between 1 to 3(low, medium, high).
Rules regarding how to give score for each risk are defined in your risk
management plan.
If the risk is adjudged on a 9-point scale then risk score for a particular risk
getting a score of 1for probability and 9 for impact will be
Risk Score =Probability Score X Impact Score
Risk Score =1 X 9 =9
Since probability and impact, are subjectively decided, organization
managing the risk creates some guidelines to ensure that these are
consistent.
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Probability Table
Probability Category
Probability Score
Description
Very High
5
Risk events are
expected to occur
High
4
Risk events are more
likely than not to occur
Probable
3
Risk events may or may
not occur
Low
2
Risk events are less to
than not to occur
Very Low
1
Risk events are not
expected to occur
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Impact Table
Project
Objective
Very low
(1)
Cost
Moderate
(3)
High
(4)
Very high
(5)
Insignificant < 10% cost
cost impact impact
10%-20%
cost impact
20%-40%
cost impact
>40% cost
impact
Schedule
Insignificant <5%
schedule
schedule
impact
impact
5% -10%
schedule
impact
10%-20%
schedule
impact
>20%
schedule
impact
Scope
Barely
noticeable
Minor areas Major areas Changes
impacted
impacted
unaccepted
to client
Product
becomes
effectively
useless
Quality
Barely
noticeable
Minor
functions
impacted
Product
becomes
effectively
useless
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Low
(2)
Client must
approve
quality
reduction
Quality
reduction
unaccepted
to client
36
Probability
Probability and Impact Matrix
1
2
3
4
5
1
1
2
3
4
5
2
2
4
6
8
10
3
3
6
9
12
15
4
4
8
12
16
20
5
5
10
15
20
25
Impact
Q1=4, Q2=8, Q3=12
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Probability
Probability and Impact Matrix
Very low Low
Medium High
Very
High
Very low
Low
low
Low
Medium
Low
Low
Low
Medium Medium
Medium
Low
Medium High
High
High
High
Low
Medium High
High
High
Very High
Medium High
High
High
High
Low
High
Impact
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Probability and Impact Matrix
If happened can be
coped up with and
move on but should try
to reduce probability
Probability
High Probability
Low Impact
Can be ignored
safely
Low Probability
Low Impact
This is of critical
importance, should be
paid close attention
High Impact
High Probability
Very unlikely to happen,
focus should be on
reducing impact
High Impact
Low Probability
Impact
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Subjective expected utility
Ei
E1
E2
EMV
P(Ei)
0.5
0.5
A1
1000
0
500
A2
500
500
500
EMV, expected monetary value
From Hardaker et al., 1999, p87
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Decision Tree Analysis
Quantity of
Fertilizer
Applied
Weather
conditions
(Probability)
Good
Maximum
0.6
Bad
0.4
A Decision
Good
Minimum
0.6
Bad
0.4
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Outcome
$2000
$-375
$1300
$300
41
Pay-off Matrix
Events
Probability
E1 Good
Weather
E2 Bad
Weather
EMV
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0.6
Maximum
Fertilizer
D1
2000
Minimum
Fertilizer
D2
1300
0.4
-375
300
1050
900
42
Risk Vs Utility
U(aj) = E[U(aj)], the utility of a risky event is the
expected value of it:
=> U(a1)= 0.5*U(1000) + 0.5*U(0)= U(a2)= U(300)
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Expected Monitory Value, Standard
Deviation and Relative Risk
Status of
rainfall
Cotton
Jowar
Probability
Profit
Probability
Profit
Very Good
0.2
50
0.2
30
Average
0.5
20
0.4
20
No rain
0.3
0
0.4
10
Expected Value 1.0
20
1.0
18
Standard
Deviation
17.32
7.48
Relative risk
(C.V)
0.866
0.41
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Adopted from Ahuja, H. L. (2012), Advanced Economic Theory:
pp 370-371
44
Pay-off Matrix
good
bad
medium
decision A
2000
-375
800
decision B
1300
300
600
decision C
100
500
200
Decision A decision B
decision C
Count
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Decision Rules
– Non probabilistic
• Wald criterion
• Salvage criterion
– Probabilistic
• Hurwicz Criterion
• Laplace Criterion
• Bayes Criterion
=> Take probabilities of appearance into account
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Wald maximax and maximin criteria
•
•
•
•
Very optimistic or pessimistic vision
Only best and worst scenario
Max ( maxj Uij)
maximalisation of maximum (risk taker)
Max ( minj Uij)
maximalisation of minimum (risk averse)
maximax
decision A
decision B
decision C
good
2000
1300
100
bad
-375
300
500
medium
800
600
200
decision A
decision B
decision C
good
2000
1300
100
bad
-375
300
500
medium
800
600
200
maximin
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Savage regret criterion or minimax
criterion
• minimise ex-post regret
• regret:
Rij = Uij – max Uij
• Min R = Min (Max Rij )
good
bad
medium
2000
-375
800
decision B
1300
300
600
decision C
100
500
200
• Regret matrix:
decision A
decision A
decision B
decision C
good
0
-700
-1900
bad
-875
-200
0
medium
0
-200
-600
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Hurwicz criterion
• the Hurwicz criterium takes into account the probability of
appearance by means of an optimism index. Only the
maximum and minimum are used.
• Max (p (max Uij ) + (1-p) (min Uij) )
• Optimism index: 0.3
decision A
decision B
decision C
A:
B:
C:
good
2000
1300
100
bad
-375
300
500
medium
800
600
200
0.3 * 2000 + 0.7 * (-375) = 337.5
0.3 * 1300 + 0.7 * 300 = 600
0.3 * 500 + 0.7 * 100 = 220
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Laplace criterion
• each situation has the same probability
• Max ( Σ Uij ) /n
good
bad
medium
decision A
2000
-375
800
decision B
1300
300
600
decision C
100
500
200
A:
B:
(2000 -375 + 800) /3 = 808.3
(1300 + 300 + 600) / 3 = 733.3
C:
(100 + 500 + 200) / 3 = 266.6
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Bayes criterion
• each situation has his own probability
• Max (Σ pi Uij )/n
decision A
decision B
decision C
probability
A:
B:
C:
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good
2000
1300
100
0.3
bad
-375
300
500
0.2
medium
800
600
200
0.5
0.3 * 2000 + 0.2 * (-375) + 0.5 * 800 = 925
0.3 * 1300 + 0.2 * 300 + 0.5 * 600 = 990.2
0.3 * 100 + 0.2 * 500 + 0.5 * 200 = 230
51
4. Plan risk Response
•Responding to risk
oHow to decrease the possibility of
negative risk affecting the objectives.
oHow to increase the possibility of
positive risk helping the objectives.
Negative Risk
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Positive Risk
Avoid
Exploit
Mitigate
Enhance
Transfer
Share
Accept
Accept
52
5. Monitor and Control Risk
•Regularly review the identified risks and ensure
that these are still relevant
oIdentify new risk
oRemove risk from risk register that are not
relevant anymore
•Risk audits may be conducted to ensure that
the plan is being implemented and is effective.
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