Quantifying the extent to which enterprise mix diversification can mitigate economic risk in rainfed agriculture

Climate variability can induce uncertainty in yields, and threaten long term economic viability of rainfed agricultural enterprises in the absence of effective adaptation strategies. Enterprise mix diversification has been found to be an effective adaptation strategy for mitigating multiple sources of farm business risk in some contexts. The extent to which enterprise mix diversification can mitigate climate induced variability in long term net returns from rainfed agriculture is assessed in this paper. Building on APSIM modelling, the assessment applies Monte Carlo simulation, probability theory, and finance techniques, to assess the potential for enterprise mix diversification to mitigate climate-induced variability in long term economic returns from rainfed agriculture. Five alternative farm enterprise types comprising three non-diversified farm enterprises and two diversified farm enterprises consisting of a correlated mix of rainfed agricultural activities were considered. The decision to switch from a non-diversified agricultural enterprise with the highest expected return to a diversified agricultural enterprise consisting of a mix of agricultural enterprises was analysed. Correlation analysis showed that yields were not perfectly correlated (i.e. are less than 1) indicating that changes in climate variables cause non-proportional impacts on yields. Results show that whilst diversification can reduce the standard deviation of net returns by up to A$122ha-1 and increase the worst probable net loss by A$99ha-1, diversification can reduce the expected net returns by up to A$96ha-1 and reduce the maximum probable net gain by up to A$602ha-1. Further, under non-diversified enterprises, the likelihood of realising net losses higher than the maximum probable net loss under the diversified enterprise was estimated at up to 6%. Conversely, under the non-diversified enterprise, the likelihood of realising net gains higher than the maximum probable net gain under diversified enterprises was estimated at up to 16%.