Risk, crop choice and saving: evidence from Tanzania

Rural households engaged in agricultural activities face considerable risks in their income process. These income risks are especially important if they result in consumption fluctuations. This is likely if insurance and credit markets are absent. One possible strategy for household is to take up low-risk activities, even if they imply lower returns. Such response cannot be viewed independently from the other options available to households to reduce consumption fluctuations. This paper focuses on the importance of liquid asset formation for risk-taking behaviour by households. An intertemporal model of consumption under liquidity constraints is developed in which households can choose between income activities with different returns and riskiness. It shows that if liquid asset holdings are large, providing a buffer for consumption shortfalls, then households will be more willing to take up high risk activities. Evidence based on survey data from Shinyanga District, Tanzania is presented, consistent with this prediction.