The story of the moment: Risk averse Cypriot farmers respond to drought management

Abstract

This paper illustrates the importance of estimating risk preferences when evaluating water policy. Using agricultural production data from the Kiti region of Cyprus we estimate farmers’ risk preferences à la Antle (1983, 1987) and show sensitivity to higher order moments of profit, such as skewness. We show that farmers in the Kiti region are risk averse with risk premiums in the region of 20% of expected profit. We use these estimates to analyse the impact of a water quota from the perspective of three policy-makers who differ only in their understanding of farmers’ risk preferences. We show in the case of Kiti that policy-makers who model risk preferences incorrectly, that is, either; a) assume risk neutrality or; b) ignore down-side risk, wrongly predict the magnitude and direction of input responses and therefore the magnitude of welfare changes. This highlights the importance of accommodating preferences for higher order moments of profit in the evaluation of water policy.