Theory of Prudent Farm Households and Agricultural Insurance

A farm household is prudent, in the sense that savings is used to hedge against future contigencies.This paper shows that a precautionary saving impinges in a non-trivial fashion on the extent to how much to produce.An expected utility-maximizing, prudent farm household may find it optimal to produce either more, less or the same level of output as that which maximizes expected utility of terminal wealth or profits.The conditions for such behavior show that risk aversion is not sufficient for a prudent farm household to reduce output under risk.The conditions that put restrictions on the measures of prudence as well as the magnitudes of wealth and direct effects provide a characterization of the level of output.However, if market insurance is available at actuarially fair rate, a complete insurance is still optimal for prudent farm households.Prudent behavior may explain low participation rates for public programs to reduce farm income variation.