The foregone risk premium: a communicative and practical method for the evaluation of risk-return profiles in agriculture
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Risk considerations have become increasingly important in nowadays agriculture, due to a variety of
reasons. Surprisingly, the practice of formalized risk management is not widespread despite the huge
amount of scientific literature on this topic. This discrepancy between risk science and extension is
described by many authors. This paper presents a communicative method, rooted in financial economics, to
evaluate risk-return profiles in a way that is communicative for individual farmers. The method is derived
from the modern portfolio theory, in which individual assets are implicitly compared to the risk-return
trade-off of that asset with the highest Sharpe ratio. We use this idea to compare individual risk-return
profiles to a particular benchmark. The method can be used for evaluating different risk-return profiles of
different farms, different risk management instruments and different production systems. To illustrate the
communicative nature of our method, it is applied to evaluate risk-return profiles of conventional versus
organic cropping systems.