Does Diversification in the Face of Increased Climate Risks Depend on Individual Risk Preferences? Evidence from Rondônia, Brazil

Risk exposure and risk management are inherent to smallholder farmers and their activities. One of the larger risks farmers are facing is climate change. Climate change decreases rainfall, increases frequency of drought, adds heat stress to crops from higher temperatures, and leads to higher variability in rainfall. The threat of rainfall variability causes higher production in some years and lower production in others. Even if the average income remains the same year to year, people that tend to be risk averse don’t like the uncertainty. This will be particularly true if they don’t have a safety net to help them weather a bad year. Diversification is one of the key adaption strategies that may help reduce climate risk. Farmers diversify by constructing an increasingly diverse portfolio of activities. Diversified farmers may produce multiple types of crops, sell things like milk and livestock, or look to off-farm sources like jobs or rental income. Rainfall variability is one type of risk that may continue to grow as the earth faces higher rates of climate change. It is useful to understand how farmers adapt to this risk as they move forward and face potentially even higher variabilities in their seasonal rainfall. Looking into how households make decisions based on their own risk attitudes and increasing environmental risk will aid policy makers in crafting policy to alleviate the burden on smallholder farmers. A diversification strategy, rather than specializing in the most profitable activity, can result in a tradeoff. Choosing to diversify could lead to lower average income but in return farmers would benefit from less variable income. Farmer’s likelihood to adopt a diversification strategy in the face of increased rainfall variability could likely depend on their attitudes towards risk. People will have different attitudes towards risk in general, with some more naturally open to risks, others more averse. This paper aims to answer the question, does diversification in the face of increased climate risk depend on the individual risk attitudes of smallholder farmers? To answer this question, I use a data set from a survey conducted in 2019 by the Connections Between Water and Rural Production project containing observations on 1,267 smallholder farming households in Rondônia, Brazil. I estimate a linear regression model of diversification as a function of risk preferences, the standard deviation of rain, and their interaction. I also control for average rainfall and farm lot and household characteristics. Previous studies have looked at how climate or rainfall affect diversification as well as how risk attitudes affect diversification. However, few studies consider the fact that these two things are likely to interact. Rainfall variability changes the riskiness of focusing on a single form of income. Some farmers, dependent on their risk attitudes, will be okay with that while others will not. There will likely be tradeoffs for those who diversify in the form of lower income to attain higher levels of security. My work will investigate whether the impacts of rainfall variability on diversification vary with risk attitudes. The preliminary results of the initial regression, which did not include an interaction term between rainfall variability and risk attitudes, showed that neither risk attitudes nor rainfall variability were statistically significant in determining levels of diversification. It did show that the age of the household head and the size of the lot were statistically significant. I will do further work to create interaction terms and run further regressions to determine whether the impact of rainfall variability on diversification varies with risk attitudes