households under uncertainty. The central idea of this study is, however, to analyze asset accumulation, particularly of livestock, as a substitute of insurance in the face of crop income shocks. This raises the need to investigate the portfolio decisions of households. Therefore, we ...rst give some insights into the possible portfolio composition of rural households in Ethiopia.

Farmers in rural Ethiopia primarily hold their assets in the form of livestock, grain stocks, farm tools and implements, and so forth. For various reasons, it is very rare for these farmers to hold balances in the formal ...nancial institutions.<sup>2</sup> First, the formal ...nancial institutions are at rudimentary stages and they are hardly accessible to rural households. Second, farmers have little information about the terms and conditions of these institutions which are located in major urban areas of the country. Further, the transfer of rural land by sale, lease or mortgage has been prohibited since the 1975 proclamation that put rural land under the control of the government. The proclamation consequently abolished any form of private land ownership and replaced it by an arrangement that provides farmers only usufruct rights. In this situation land cannot be used either as a bu¤er stock or as collateral to borrow money in response to adverse income shocks. Nonetheless, the size and quality of land are identi...ed as the second most important basis for wealth ranking, next to livestock, in the 15 villages covered by the rural household survey. This ...nding is based on the community wealth ranking exercise conducted in these villages (see Bevan and Bereket, 1996 for the details on the data based discussion of measuring wealth in rural Ethiopia).

Taking the above facts into account, we consider only two assets, namely, a risky and a safe asset. The availability of a safe asset with a known rate of return has been challenged in the literature on the basis of its lack of realism even in economies with a high degree of price predictability (Sandmo, 1969). The problem is much more critical in countries like Ethiopia where economic activities are highly risky. Analytically, however, it is perfectly plausible to assume the existence of assets which are relatively safe and assets which are relatively risky, which provides a sound justi...cation for the setup of our model with only two assets. The risky asset is cattle that are directly used in agricultural production while the relatively safe asset with a known rate of return includes grain stocks or small animals such as sheep and goats. This classi...cation is quite realistic taking the settings of the rural areas into account, i.e., a mixed farming system that mainly incorporates subsistence crop production and livestock rearing.

Let us now introduce additional assumptions that give more structure to the analysis. We assume the existence of food and livestock markets, but an absence of insurance and credit markets. This implies that households cannot trade risks among themselves

> 2For example, only 12 out of 1477 households reported that at least one household member had a bank account at the ...rst round interview of the rural household survey.

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