Risk is the possibility of adversity or loss, and refers to “uncertainty that matters.” Consequently, risk management involves choosing among alternatives to reduce the effects of risk. It typically requires the evaluation of tradeoffs between changes in risk, expected returns, entrepreneurial freedom, and other variables.

Understanding risk is a starting point to help producers make good management choices in situations where adversity and loss are possibilities.

Meaning of Risk

There are many definitions of the term risk, which are examined herein to appreciate its nature. An array of definitions is reviewed below to establish a framework for the discussion of risk. According to Bodie and Merton (1998), risk can be defined as uncertainty that affects an individual’s welfare and is often associated with adversity and loss.

Risk can also be defined as uncertainty that “matters,” and may involve the probability of losing money, possible harm to human health, repercussions that affect resources (irrigation, credit), and other types of events that affect a person’s welfare.

Uncertainty (a situation in which a person does not know for sure what will happen) is necessary for risk to occur, but uncertainty need not lead to a risky situation.

Risk is a variability or outcome that is measurable in an empirical or quantitative manner. The outcome for each particular item need not be predictable. It is also defined as a situation that exists when the future can be predicted with a specified degree of probability.

According to Esheya (2011), when a risk situation prevails, one can state that the chances are, for instance, 50-50 or 75-25 that an event will occur. Jhingan (2006) sees risk as a situation where the probability of obtaining some outcomes of an event is not precisely known.

That is, known probabilities cannot be precisely assigned to these outcomes, but their general level can be inferred. Ebong (2000) defined risk as a situation where all possible outcomes are known for a given activity, and the probability associated with each outcome is also known.

Claire Schaffnit-Chatterjee (2010) defined risk as the potential deviation between expected and real outcomes. While this deviation may be positive or negative, a negative outcome has greater importance from a practical point of view and is usually the focus of decision-makers.

Decision-making takes place in an environment of imperfect knowledge of the future uncertainty and is associated with risk, which is normally defined as “uncertainty of outcomes” resulting in losses negatively affecting an individual’s welfare.

Risk is also defined more simply as a loss due to a damaging event. The advantage of this definition is that it can be materialized and measured easily (e.g., loss of agricultural production, loss of income).

Agricultural risk is associated with negative outcomes that stem from imperfectly predictable biological, climatic, and price variables. These variables include natural adversities (for example, pests and diseases) and climatic factors not within the control of farmers.

They also include adverse changes in both input and output prices. Risk in agriculture is not only of concern to the individual farmer but also to society as a whole, as risk-averse behavior of farmers can lead to an allocation of farm resources that is not efficient, resulting in a sub-optimal overall allocation of resources and consequently lower overall welfare.

For example, risk-averse farmers may not adopt a new productivity-enhancing technology because of potential risks associated with it, which results in a lower increase in output than possible.

Exposure to risk prevents farmers from easily planning ahead and making investments. In turn, risk inhibits external parties’ willingness to invest in agriculture because of the uncertainty about the expected returns.

Improved management of agricultural risk has significant potential to increase productivity-enhancing investments in agriculture (World Bank, 2005).

Examples of Risks in Agriculture

1. Maize Marketing Example

A maize farmer at harvest is faced with two options regarding the sale of his crop. He must decide whether to sell the maize now at the current price or store it for future sale, aiming to sell at a higher price.

The first option ensures a return on his harvest, but if he chooses the second option, he will incur storage costs and potential losses due to spoilage. Additionally, he is uncertain about the future price, which may fall or rise.

If the price rises, he will make a profit, but the gain depends on the difference between the current and future prices. If, on the other hand, there is an increase in the supply of maize in the future, leading to a fall in price, the farmer may incur significant losses from the decision to store rather than sell.

This risk is hinged on the fact that the farmer has no knowledge of the future price at the time of decision-making.

2. Disease Outbreak Example

A poultry farmer may decide to vaccinate or not vaccinate his broilers. There is a probability that there will be no outbreak of disease, and the farmer would have minimized costs and maximized profit.

However, an outbreak of disease may result in the loss of the entire flock, leading to significant losses for the farmer. Sometimes, even after observing all necessary vaccinations, the risk of losses due to disease outbreaks cannot be ruled out.

These examples underscore the importance of risk in agriculture. Indeed, risks and uncertainties are integral to all walks of life. For instance, marital decisions such as who a man or woman marries are characterized by risks and uncertainties because one cannot predict what that person will become in the future.

However, one should not be afraid of risk in life, farm business, or any other enterprise. Rather, the concern should be how to manage risk as an individual or organization. It should also be noted that profit is a reward for risk-bearing.

All things being equal, the higher the risk associated with an investment, the greater the expected income or profit.

3. Classification of Risk

Risk situations may be classified as a priori or statistical.

i. A Priori Probability

A priori probability prevails when sufficient information is known in advance about the general possibilities, and the probability of a particular event occurring can be specified. For example, if a fair coin is tossed once without bias, it must come up either heads or tails. Thus, the result of this experiment is predictable.

The a priori probability of an outcome can be established when the characteristics of the eventuality are known beforehand. Thus, it can be predicted with certainty that, with continuous rolls of a perfect dice, a 4 is a possible outcome out of several trials.

It follows that one who engages in a game of chance is not faced with uncertainty but with risk. Although the outcome of a single game cannot be predicted without error, the outcome over a large number of trials is certain.

ii. Statistical Risk

In statistical risk, the probability of a future event can be stated based on observed results from many observations. Here, probabilities are assigned to future events based on recorded experiences of what has happened under similar circumstances.

An example is the increase in pests and diseases of crops and livestock with the occurrence of late rainfall. The statistical probability of an outcome can be established when:

i. The sample of cases or observations is large enough.

ii. The observations are repeated in the population.

iii. The observations are independent or randomly distributed in the manner of a stochastic variable.

Insurance companies can predict the statistical probability of deaths, fire losses, and similar outcomes with a degree of certainty only when the number of cases or observations is sufficiently large and randomly distributed (Esheya, 2011).

4. Nature of Agricultural Risk

Risk is an unavoidable element in the business of agriculture. Production can vary widely from year to year due to unforeseen weather and market conditions, causing wide swings in commodity prices. However, while risk is inevitable, it is often manageable.

Farmers make decisions in a risky, ever-changing environment. The consequences of their decisions are generally not known when the decisions are made, and outcomes may be better or worse than expected. Variability in prices and yields are major sources of risk in agriculture.

Changes in technology, legal and social concerns, and the human factor itself also contribute to the risky environment for farmers. Risky situations of concern are typically those in which:

i. There is a high possibility of adverse consequences.

ii. The adverse consequences, should they occur, would cause significant disruptions.

Farmers and other businesspeople generally do not engage in risky situations unless there is a probability of making money. Higher profits are typically associated with higher risks. It is to their advantage that these risky but potentially profitable situations be managed as carefully as possible.

The following deductions underline the nature of agricultural risk:

i. Agricultural risk varies in its possible occurrence and outcomes or consequences.

ii. The occurrence of agricultural risk and its outcomes depend on chance.

iii. Risk is characterized by uncertainty with respect to its occurrence and the magnitude of loss.

iv. Risk refers to uncertainty because it is inherently linked to uncertainty or the chance of a loss.

v. Risk has been described as the possibility that loss will be greater than normal, expected, or usual.

Hence, the nature of risk is the premise upon which the rationale for risk mitigation or management is based, due to its unpredictable occurrence in most cases and the magnitude of the loss that accompanies it when it arises.

It is therefore imperative to understand the nature of agricultural risk so that farmers, farm managers, and agribusiness enterprises can prepare and institute essential measures for mitigating, managing, coping with, or even precluding it from occurring.

5. Decision Environments

The environments under which decisions may be made can be classified based on the availability of complete and accurate information and how perfectly the decision-maker may predict the state of nature and the result of their decision. These categories are as follows:

i. Certainty: This is the state in which the decision-maker knows in advance the specific outcome of each alternative. It implies that all relevant parameters, such as costs, capacity, demand, and so on, have known values.

ii. Risk: This is the state of knowledge in which each of the alternative strategies leads to one of a set of specific outcomes, with each outcome occurring with a probability that is known to the decision-maker.

iii. Uncertainty: This is a state in which one or more alternative strategies result in a set of possible specific outcomes whose probabilities are either not known or not meaningful.

6. Risks versus Uncertainty

Risk may be defined as the potential deviation between expected and real outcomes. While this deviation may be positive or negative, a negative outcome has greater importance from a practical point of view and is usually the focus of decision-makers.

Risk is a situation where all possible outcomes are known for a given management decision, and the probability associated with each possible outcome is also known. Risk refers to variability or outcomes that are measurable in an empirical or quantitative manner.

Risk is insurable. Risk is uncertainty that affects an individual’s welfare and is often associated with adversity and loss. Risk is uncertainty that “matters,” and may involve the probability of losing money, possible harm to human health, repercussions that affect resources (irrigation, credit), and other types of events that affect a person’s welfare.

Uncertainty is said to exist when either all possible outcomes are not known, or the probabilities of the outcomes are not known, or neither the outcomes nor the probabilities are known.

It is a situation in which the probability of obtaining the outcome(s) of an event is not known. There is thus a plurality of possible outcomes to which no objective probability can be attached. Here, there is no valid basis for assigning any kind of probability to future events.

In contrast to pure risk, the probability of an outcome cannot be established in an empirical or quantitative sense for uncertainty.

This is present when knowledge of the future is less than perfect in the sense that the parameters of the probability distribution (mean yield or price, variance, range or dispersion, skewness, and kurtosis or shape of the distribution) cannot be determined. It refers to anticipation of the future and is peculiar to the mind of each individual producer.

Uncertainty arises because the manager must formulate an image of the future in their mind but has no quantitative manner by which these predictions can be verified. Uncertainty simply refers to future events where the parameters of the probability distribution cannot be determined empirically. It involves making decisions with less than perfect knowledge.

Anticipations of the future can be formed, but there is no way that the farm manager can assemble enough homogeneous observations to predict the relevant probability distribution. Thus, they are forced to make decisions without adequate information but formulate some expectations of the most likely outcome.

They arrive at a decision by making estimates of the future and decide what outcome is most likely, depending on the confidence they place in the outcome, then commit some resources to this plan of action.

An example of uncertainty is determining the best time to dispose of palm oil as a farm produce to seek the most profitable alternative. Since knowledge of the future is so imperfect, managers normally expect that a range of outcomes, rather than a single outcome, is possible (Esheya, 2011).

Uncertainty refers to risks that take place in an atmosphere of imperfect knowledge. In other words, the probability of occurrence cannot be determined. While the outcomes of risk are certain, the outcomes of uncertainty are uncertain. Risk can be managed, but uncertainty cannot be managed.

All possible outcomes are unknown; the probability of the outcomes is unknown. Uncertainty refers to future events where the parameters of the probability distribution (mean yield or price, variance, range or dispersion, and skewness and kurtosis) cannot be determined empirically.

Uncertainty is not insurable. Uncertainty (a situation in which a person does not know for sure what will happen) is necessary for risk to occur, but uncertainty need not lead to a risky situation.

In this article, it has been observed that risk is an unavoidable element in the business of agriculture. As a result, farmers make decisions in a risky, ever-changing environment. The consequences of these decisions are unknown at the time they are made, as decisions are often made several months or even years prior to the harvest season.

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