**Table 2.  Examples of risk management arrangements**

|Arrangement<br>Strategies|Technical|Financial|
|---|---|---|
|Risk Management|- Low-risk productive pathways<br>- Pest prevention (pesticides,<br>herbicides...)<br>- Livestock disease prevention<br>(vaccination...)<br>- On-farm diversification (crop<br>rotation, livestock and crops...)<br>-Off-farmdiversification|- Insurance<br>- Hedging<br>- Savings<br>- Contingent borrowing|

Sources: Authors, based on Holzmann and Jorgensen (2000) and Anderson (2001).

Given the multiple risks affecting farmers’ income and consumption and the multiple risk management and risk coping arrangements that exist, it would be unrealistic to treat all these heterogeneous risks and risk financing instruments in a single framework. As a consequence, the approach adopted in this study first decomposes the risk by separating price and crop yield risks with a view to focusing on the latter. We then examine formal marketbased instruments (insurance/hedging and savings/credit) that can be effective in managing this agricultural production risk<sup>34</sup> Thus, this paper should be viewed as a first module to be combined with other modules dealing with other sources of risk faced by farmers in a comprehensive analytical approach to the variability of income in agriculture.

# **3. Crop Business Viability**

In this market-based framework, farming is viewed as a business activity exposed to multiple production risks. These sources of uncertainty in the short-run can affect the crop business profitability, and in the long run the business viability, in the worst cases, leading to insolvency.

A three-step approach is proposed to analyze the viability of crop business, as depicted on Figure 1. First, the yield risk characteristics of the specified crop are analyzed, where the catastrophic and non-catastrophic components of the risk are separated. The crop business profitability is assessed based on the comparison between the crop yield pattern and the production costs. The minimum business capital requirements allowing the farmer to stay in business are then derived. Second, we examine the farmer’s financial profile, and especially his asset base, which determines his ability to utilize internal resources to meet his business capital requirements prescribed by the necessity to absorb the economic consequences of adverse production shocks. Third, the viability of the crop business is tested by comparing the minimum capital requirements with the farmer’s asset base. The comparison also allows to determine whether additional external sources of capital (insurance, savings/borrowings) are needed to enhance or restore the farmer’s risk retention capabilities. Hence, this market-based approach (i) enables to establish whether the farmer’s asset base is sufficient to meet the

> 3 This paper does not discuss the design of cost-effective insurance/hedging contracts. Consequently, insurance and hedging are broadly viewed as synonymous, i.e., as risk transfer instruments between two parties. 4 Although, under certain circumstances (such as market failures), formal credit and insurance markets may be ineffective in reducing income risk and its consequences (Dercon 2002), the market based approach developed in this paper will allow us to build a framework in which complex issues of insurance economics can be examined using mathematical tools and, to some extent, simulation models.

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