activities such as o¤-farm activities. In contrast, Fafchamps, Udry and Czukas (1998) ...nd that livestock transactions play less of a consumption smoothing role in the face of rainfall shocks than often expected in West Africa, though their framework does not explicitly consider production decisions. Results from Burkina Faso also provide very little evidence for livestock to be used as an e¤ective risk- coping strategy even in the face of idiosyncratic income shocks (Kazianga and Udry, 2006).

Ethiopia is a good country to test the hypothesis that assets, particularly livestock, are used as bu¤er stocks during bad years. The livelihood of the rural population in Ethiopia relies on rainfed subsistence agriculture. Animal husbandry is an important component of the farming system in the country. Livestock are highly integrated in the process of crop production as a source of draught power, to transport agricultural produce and inputs from farm to home and then to the market, as a source of food (meat and milk) and as a source of income from the sale of livestock products and live animals to cushion the e¤ect of crop income shocks and to supplement the working capital needs of farm households (see Gryseels, 1988 and Mohammed and Abiy, 1996 for the details). Gryseels et al. (1984), quoted in Mohammed and Abiy (1996), indicate that the number of oxen owned by farmers in‡uences their choice of crops as well as the size of their cultivated area. Farmers with less draught power cultivate relatively small areas in order to minimize losses in yields arising from a delay in the time of sowing. This problem is exacerbated due to the covariance in the timing of the demand for animal traction, which limits the rental market of oxen. Based on preliminary data analysis from the ...rst round of the Ethiopian Rural Household Survey, Krishnan (1995) found that ownership of livestock is an important source of di¤erences in cultivated land and invites tenancy arrangements. Also, there is evidence that tenant households possess more livestock, particularly oxen and bulls.

Livestock are not only important as an investment in production but can also serve as an alternative for insurance in the face of ‡uctuations in income. For instance, a study by Dessalegn Rahmato (1987) on the Northeastern part of Ethiopia clearly points out that the number of livestock marketed was extraordinarily high during the 1984 famine. The issue, however, has not so far been rigorously investigated, except the work done by Daniel (1995) using time-series, macro data. The results from the study show that marginal propensity to save from transitory income predicted by rainfall is far greater than savings out of permanent income. These ...ndings imply that households on aggregate have been able to partially smooth their consumption in the face of rainfall shocks.

The aim of this study is, therefore, to test the hypothesis that households in rural Ethiopia keep livestock as a bu¤er stock. The study uses panel data collected by the Department of Economics of Addis Ababa University and the Centre for the Study of African Economies of Oxford University. For this purpose, we develop a dynamic intertemporal 2