Evaluating the magnitudes of financial transactions costs on risk behavior Joseph A. Atwood, David E. Buschena* Department of Agricultural Economics and Economics, Montana State University-Bozeman, 306 Linfield Hall, PO Box 172920, Bozeman, MT 59717-2920, USA Received 13 February 2002; accepted 28 May 2002 Abstract The model presented in this paper relies on financial constraints and transactions costs to operationalize model of behavior akin to safety rules. The decision maker is taken to maxi- mize long term (40 period) expected wealth in the presence of financial transactions costs. The model allows exploration of the implications of these constraints and transactions costs for measurable choice patterns over risk. The optimization analysis demonstrates very rich behavior despite the restrictive assumption of risk neutral preferences. The optimal decisions show instances of ‘‘risk aversion’’ with willingness to pay less than a risky option’s expected value, and of ‘‘risk preference’’ or plunging with willingness to pay greater than a risky option’s expected value. These varied behavioral patterns in the presence of risk depend on the individual’s financial standing, the magnitude of the random outcomes, the underlying distribution, and the farm policy environment. # 2002 Elsevier Science Ltd. All rights reserved. Keywords: Risk; Transaction costs; Plunging; Stochastic dynamic programming; Safety rules 1. Introduction and relevant literature The standard model for behavior under risk is a smooth utility function over wealth based on the Expected Utility model (EU) of von Neumann and Morgenstern (1944). Observed variation in behavior under the same risk environment is attributed to individuals’ underlying preferences. Theoretical and empirical inferences from this 0308-521X/03/$ - see front matter # 2002 Elsevier Science Ltd. All rights reserved. PII: S0308-521X(02)00067-7 Agricultural Systems 75 (2003) 235–249 www.elsevier.com/locate/agsy * Corresponding author: Tel.: +1-406-994-5623; fax: +1-406-994-4838. E-mail address: dbuschena@montana.edu (D.E. Buschena).