Decision making under risk : a study of models and measurement procedures with special reference to the farmer's marketing behavior

The objectives of the study were: a) to review, discuss and test a number of theories on individual decision making under risk; much attention is specifically given to the definition and empirical testing of the concept of relative risk attitude, b) to investigate in a large scale survey the validity, reliability and practical feasibility of measurement procedures for measuring subjective probability distributions, risk attitude, and strength of preference, and c) to develop and test a model which describes the farmer's decision making process with respect to the choice of a marketing strategy for ware potatoes.

The theoretical and methodological issues in this study are analyzed in the context of a farmer's choice of a marketing strategy. A field study was conducted in which a large number of farmers (250) were interviewed three times in two consecutive years.

The concept of the relative risk attitude concerns the relationship between a utility function assessed by means of lotteries and a strength of preference function assessed by means of riskless techniques. Per respondent the relative risk attitude was assessed. In both years a significant difference was found between the utility and strength of preference function. In this study therefore, the hypothesis of the relative risk attitude is confirmed. Moreover, the relationship between the functions can be described by the hypothesized negative exponential relationship. This means that the farmers exhibit a constant absolute and an increasing proportional relative risk attitude. The implications of the findings concerning the relative risk attitude are given.

An evaluation was given of models originating from utility theory and behavioral decision theory (such as Prospect Theory). It was concluded that the subjective expected utility model is still the most useful model for analyzing decision making under risk. We applied this model to explain the farmer's marketing decision making process. Results show that, in both years, the subjective expected utility model outperformed the subjective expective value model in predictive validity. The farmer's risk attitude therefore significantly influences his prefences for marketing strategies. However, the increment in predictive validity due to taking the risk attitude into account was relatively small. This finding was attributed to the high percentage of pairwise second degree of stochastic dominant subjective probability functions.

A multiple method procedure was applied in the assessment of both risk attitude (that is, conjoint measurement and a standard lottery method) and strength of preference (that is, the midvalue splitting and the rating technique). The stability and convergent validity of the measurements were assessed. The results showed significant annual test-retest correlations ranging from 0.19 to 0.45. When conceiving risk attitude as a latent variable measured by two indicators the stability correlation is 0.82 (LISREL-estimate); likewise the stability of the latent variable strength of preference is 0.61. Convergent correlations were all statistically significant and ranged from 0.15 to 0.49. Further comparisons between the measurement techniques concerned the sensitivity to response effects, interviewer bias and practical feasibility.

With respect to the measurement of risk perception two methods were compared, the so- called indirect and direct method. In the indirect method a subjective probability distribution is obtained whereas with the direct method the first two moments of the distribution are directly assessed. Both methods yielded valid and plausible results and the correspondence in measurements between both methods was high. Since the direct method is more easy to apply to both the respondent and the interviewer and the predictive validity of models using data from both methods was equally high, the results in this study suggest that the direct method is to be prefered in survey research.

Little empirical research deals with the farmer's marketing behavior under risk. In this study the marketing strategy with respect to ware potatoes, the farmers' most important crop, is analysed. To whom, when and how much to sell per selling-option are the major decisions. Typically, farmers choose a combination of selling -options, e.g. a fixed-price contract combined with selling at the spot market.

The farmer's choice process was modeled by means of two attributes: price and marketing channel. This hypothesized two-attribute model was confirmed in both years of measurement. Furthermore, the farmers in the study can be characterised by a constant absolute and an increasing proportional risk attitude. Only a small percentage of farmers are slightly risk seeking, all others are risk neutral to risk averse. Differences between farmers in degree of risk aversion are substantial. However, few consistent relationships were found between the farmer's risk attitude and personal and situational variables.

Implications of the results of the study and suggestions for further research are given.