A Monte Carlo model for simulating insufficiently remunerating risk premium: case of market failure in organic farming

Starting from the farm management question whether increased risk in nowadays agricultural activities is paid for, a Monte Carlo income simulation model is built to calculated income risk factors and is applied to some organic cropping activities. The organic farming case is often perceived as more risky than conventional farming. The model works with measured as well as subjectively estimated expected volatility of yield, prices and various cost components and simulates return on capital employed (ROCE) and its standard deviation. Results are compared with a ``volatility-return'' benchmark derived from financial markets. This comparison given an indication whether, first, a risk premium exists, and, second, whether or not it sufficiently remunerates extra risk. Although data availability differs for both systems, they could be robustly compared through decomposing ROCE into yield, price and cost components. Main uncertainties, concerning market failure and capital input, are captured with a sensitivity analysis. Simulations mainly confirm current risk perception, but risk premium is sufficiently high to remunerate extra risk. Sensitivity analysis, however, demonstrates the vulnerability for market failures, but also reveals, unexpectedly, no effects from the absolute capital input.