LAUSR

Farmers are exposed to substantial weather and market related risks. Rational farmers seek to avoid large losses. Future climate change and energy price fluctuations therefore make adaptating to increased risks particularly important for them. Managing soil natural capital—the capacity of the soil to generate ecosystem services of benefit to farmers—has been proven to generate the double dividend: increasing farm profit and reducing associated risk. In this paper we explore whether managing soil natural capital has a third dividend: reducing the downside risk (increasing the positive skewness of profit). This we refer to as the prudence effect which can be viewed as an adaptation strategy for dealing with future uncertainties through more prudent management of soil natural capital. We do this by developing a dynamic stochastic portfolio model to optimize the stock of soil natural capital—as indicated by soil organic carbon (SOC) content—that considers the mean, variance and skewness of profits from arable farming. The SOC state variable can be managed by the farmer only indirectly through the spatial and temporal allocation of land use. We model four cash crops and a grass ley that generates no market return but replenishes SOC. We find that managing soil natural capital can, not only improve farm profit while reducing the risk, but also reduce the downside risk. Prudent adaptation to future risks should therefore consider the impact of current agricultural management practices on the stock of soil natural capital.