Abstract:
As extreme weather events become more frequent and severe, smallholder farmers face increasing vulnerability. Crop diversification can act as insurance against climate variability, but the presence of correlation neglect in decision-making can lead to suboptimal risk exposure. Our study examines the relationship between income diversification and correlation neglect among smallholder farmers. First, we assess the extent of correlation neglect and its impact on financial and land use decisions. Next, we examine methods to reduce correlation neglect by comparing different ways to present historical profitability data of two crops. We hypothesize that integrating information, such as presenting both crops' returns together, enhances the comparison of investment options and reduces cognitive limitations contributing to correlation neglect. To test our hypotheses, we conducted a framed lab-in-the-field experiment with 220 smallholder farmers in rural Brazil, assessing investment decisions based on different information treatments. We found that participants do not completely neglect the correlation among crops’ returns: the lower the degree of correlation, the more diverse are the investment decisions. However, the correlation is not accounted for optimally, as the diversification is higher than theoretically expected. Integrated information leads to higher diversification in both financial and land use decisions compared with segregated information, and significantly decreases correlation neglect in crop allocations. Lastly, higher belief accuracy might explain the differences across treatments. Our study contributes to the empirical literature on correlation neglect as the first that focuses not on student or financial literate individuals, but on real farmers in the context of agricultural decision-making in a developing country.
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