**Policy, Planning, and Research**

## **Agricultural Policies**

Incorporating risk assessmetnt into public project appraisal makes sensc when project risk is significantily corrclated with uncertainty about national income. It is especially important in countries that specialize in particular agricultural or resource sectors.

Calculating costs and returns is similar for real and financial investments - but the treatment of risk is bctter developed for financial investmcnts. Dixit and Williamson prescnt a - pilot model analogous to the capital asset pricing model - that relates the excess rcturn required from a project to project risk.

# Dixit and Williamson found tlhat:

Risk corrections can be substantial. The size of' thc adjustment is affected by the cocfi'ficicnt of variation of GNP, thc coefficicnt ol'variation lor project retum, and the correlation between GNP and project rctum.

The intuition thalt risk is grceat for furtlher investment in a crop or sector that constituics a large part of a country's GNP is not invalid, but this c'ffcct may bc offset b) other forces in operation.

espccially attractivc. It will bc useful to know how **1o** identify them.

Risk premia vary greatly across countries and sectors - so recognizing the risk correctioi needed for each project on its own merits maikes morc scnse than including a common general risk premium in the rate of return required for all leInding. The rcsult would be a reallocation of' lending among projects, not a stiffening of standards for all projects and therefore acceptance of fcwer.

Risk corrections are small for many sectors and countrics. Identifying risk in project appraisal will be simplified if a general cl-'s of country and sector combinations can bc ..lentifled in which risk is negligible - so efforts can bc concentrated on the other categories, wherc the proposed treatmcnt of risk makes a big dil'ference.

Risk affects investment projects in man)y differcnt, subtic ways. One should not aim for a simple tabic of risk adjustment terms to be read in a manual and applied directly. Even wheln **iltc** procedurc is refined, each situation will necd economic analysis and oversight.

Risk corrections can bc negative because of a negative correlation between project retum and GNP. Project risks with negLativc risk adjustments - such as projects involving ricc in Niocria and groundilut oil in Senegal - are Resource requirements for this are not greati. howevcr. After routines are developed, one professional cconomist should bc ablc to incorporate risk assessmcnt into project analysis in lcss than a week.

This paper is a product of thc Agricultural Policies Division, Agriculture and Rural Development Department. Copics arc available free from the World Bank, 1818 H Street NW, Washington DC 20433. Plcase contact Cicely Spooner, room N8-035, extcnsion 30464 (39 pages with taiblcs).

Thc PIPR Working Paper Scrics dissominates thc findings of work under waav in the Bank's Policy, Planning. and Rcscarch Complex. An **ohjcctic** of the serics is to get thcsc findings out quickly. even if prcsentations are lcss than fully polished. **Thc** findings. interpretations. and conclusions in these papers do not necessarily represcnt official policy of the Bank.

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