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- Overview Of Risk Management
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- The most important role for a farmer is that of manager. For an individual farmer (manager), risk management involves finding the preferred combination of activities with uncertain outcomes and varying levels of expected returns.
Risk management can then be defined as choosing among alternatives to reduce the effects of risk. This requires an evaluation of tradeoff between changes in risk, expected returns and entrepreneurial freedom among others. The focus must be on the “risk that matters.” This may involve the prospect of losing money, possible harm to human health, repercussions that affect resources or other events that affect a person’s welfare.
Seven Steps to Risk Management
1. Risk Identification—Categorization.
2. Risk Measurement.
3. Risk Capacity.
4. Risk Willingness (Preference).
5. Set Goals.
6. Identify Tools.
7. Select Professionals to Assist.
Probabilities are simply a way of expressing the chances of various outcomes. Weather forecasts use probabilities. For example, they may indicate a 20 percent chance of rain or a 40 percent chance of snow. At the start of a football game, a coin is flipped. What are the chances or probabilities that it will come up “heads”? Fifty percent or one half. The chances for “tails” are exactly the same.
Variability of outcomes is generally associated with risk, and typically riskier situations have greater variability of outcomes. The average outcome is the most frequent or most likely if outcomes are normally distributed, but the average does not provide information about variability. The range—the highest and lowest values—combined with the average does provide some information about variability. However, it is difficult to make comparisons of variability between crops or prices.
The coefficient of variation is a statistical measure of variability based on all of the values for yields or prices, not just the high, low, and average. Many baseball fans do not know how to compute a pitcher's earned run average, but they use earned run averages to make comparisons among pitchers. In a similar way, these coefficients of variation can be used to make comparisons of variability among crop yields or prices. The lower the coefficient of variation, the lower the variability.
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