Can Risk Reducing Policies Reduce Farmer's Risk and Improve Their Welfare?

This paper develops an analytical model able to represent the decisions of an individual risk averse farmer facing variability in both prices and yields. A comprehensive set of stylised risk reducing policy measures is represented. A calibration of the model is used to run Monte-Carlo simulations and to obtain optimal responses. The main focus is the interaction between policy measures and market strategies in terms of impacts on production, welfare and risk. Risk reducing strategies that cover different sources of risk, such as price and yield variability, may be complementary for the farmers. Counter-cyclical area payments create incentives to bring land into production and their capacity to reduce farming risk is mitigated by the potential crowding out of substitutive market strategies. They are found to be more transfer efficient in terms of profit, but the impact on the farmer's welfare depends on the trade-off between optimal farm return and farm income variability reflected in the farmer's risk aversion. The policy package set up by the government matters because measures interact between each other, particularly when market mechanisms are available. In general, it is found that market mechanisms are better suited for reducing the relevant risk of farmers. Optimal policy mix crucially depends on the government objective, and there can be a trade off between risk reduction and farmers' welfare.