2210-7843 © 2010 Published by Elsevier B.V. doi:10.1016/j.aaspro.2010.09.010 Agriculture and Agricultural Science Procedia 1 (2010) 76–89 Available online at www.sciencedirect.com International Conference on Agricultural Risk and Food Security 2010 A Monte Carlo model for simulating insufficiently remunerating risk premium: case of market failure in organic farming Ludwig Lauwers a,b , Lieve Decock a , Jan Dewit c , Erwin Wauters a * a ILVO, Institute for Agricultural and Fisheries Research – Social Sciences Unit, Merelbeke, Belgium b UGent, Ghent University – Department of Agricultural Economics, Ghent, Belgium c LBI, Louis Bolk Institute, Driebergen, the Netherlands Abstract 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. © 2010 Published by Elsevier B.V. Keywords: risk; organic agriculture; Monte Carlo simulation; triangular distribution; market failure; return on capital employed; volatility-return benchmarking 1. Introduction Currently in agriculture, an important upcoming question is whether risk is paid for. Risk is increasing due to more price volatility and yield calamities (Eakin [1], Ericksen et al. [2]) but also due to the introduction of new technologies. This is in particular true for new techniques that are vulnerable for yield failures and for products that may face market failure, which might be the case for organic farming. Indeed, organic farming as an innovative production technique proves to be potentially profitable (Cavigelli [3], Kerselaers et al. [4], Tuzel et al [5]), but * Corresponding author. E-mail address: Erwin.Wauters@ilvo.vlaanderen.be; Erwin.Wauters@gmail.com