Thesis(M.S.)--Auburn University, 2006. / Abstract. Vita. Includes bibliographic references.

This dissertation examines to what extent off-farm diversification may be an appropriate and accessible tool to mitigate the adverse effects from market failures and incompleteness in the crop and farm income insurance market. While the influence of the nonfarm sector has long been recognized as a primary force in shaping farm structure, off-farm income is rarely acknowledge as a risk management tool for operators and households of commercial farms. The dissertation develops a dynamic model that includes capital market imperfections, economies of scale in farm production, and the presence of adjustment costs in labor allocation decisions. The model provides a realistic characterization of the environment defining income and financial risks faced by farm operators, as well as the risk management alternatives available to them. It is found that introducing off-farm labor can substantially mitigate the adverse effects of farm income risk on farm operators' and households' welfare, even for larger commercial farms. However, the diversification of labor by the main operator seems to impose labor and managerial constraints that can reduce the intensity and technical efficiency of the farm production. Alternatively, diversification at the household level through the allocation of spousal labor off the farm provides benefits in mitigating the adverse effects of farm income risk on farm production and efficiency, and on operators and households welfare. It thus provides an efficient risk management alternative that is consistent with most rationales that are invoked to justify farm policies. Results suggest that the increasing incidence and importance of off-farm income within the farm population of most OECD countries is highly relevant in the design of effective farm policies This form of diversification can reduce the need and effectiveness of farm income stabilization polices. While it has been argued elsewhere that broader economic policies had a large influence in closing the income gap between farm and urban households, such policies may also have a role to play in addressing farm income risk issues and, in some cases, may represent more sustainable and efficient policy alternatives.

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