From Wall St to farmers in Ghana: finance fundamentals remain the same
By Abrar Chaudhury and Chase Sova
On any given Wednesday afternoon, on the hot and dusty road connecting Orbili Village to Lawra, a small bustling district city in upper west region of Ghana, there is an unusual commotion.
Trucks, buses, and motorcycles periodically speed past the roadside shops of Orbili, greeting residents with a customary honk and a wave. As the dust slowly settles, a trickle of slow moving bicycles appear trailing the convoy. Their speeds and cargo capacities may be different, but they are all transporting the same goods – livestock purchased 20km up the road from the border towns of neighboring Burkina Faso for onward sale in markets of wealthier metropolises in South of Ghana.
So what is the rational and economics behind this weekly movement? As any finance professional would be proud to explain, two fundamental financial principles are at play here - diversification and arbitrage.
Basic finance teaches us that the higher the return, the higher the risk. A challenge for finance professionals (and infact a major source of their fees) is to create investment portfolios using sophisticated quantitative models, such as the Capital Asset Pricing Model (CAPM), to appropriately price investments at a given risk.
So how are the farmers of Orbili using the CAPM model? Well, not on a spreadsheet. But farmers and finance professionals share the same fundamental investment logic; diversification. Put simply, by adding diverse and appropriate investments in a portfolio, some individual investment risks can be diversified, thus increasing returns without proportionally increasing risks.
The farmers of Orbili are well versed with this investment logic. And it is a logic they are increasingly relying upon given the pronounced climate uncertainties facing Ghana’s Upper West.
In a survey conducted by the CGIAR Research Program on Climate Change, Agriculture and Food Security's (CCAFS), and the Oxford University’s Systemic Integrated Adaptation (SIA) group, over two-thirds (66 percent) of the respondent farmers in Orbili identified three or more diverse income sources. Unlike their counterparts in the south of Ghana, who enjoy two rainy seasons, farmers in Orbili have to rely on a single season from May to July.
With increased rainfall variability and limited official extension support, farming productivity - and hence farmers livelihoods - are exposed to high risks. To counter this, farmers that are fortunate to live close to the banks of the Black Volta River engage in dry season gardening, while others - the young and strong - make their way to affluent southern cities for casual labour. The more enterprising farmers head to Burkina Faso for livestock trading.
By diversifying their income streams, especially in the dry season, farmers increase their returns while maintaining the same risk level associated with rain variability. A classic output of CAPM.
The second finance principle at play in Orbili is arbitrage, which occurs when you take advantage of price differences between two markets.
In theory the transaction must occur simultaneously to avoid market exposure. In practice however, arbitrage can exist when you buy cheaper in one market and sell higher in another, without taking on additional risks: risk free profits. Farmers in Orbili recognize an arbitrage opportunity in the markets of Burkina Faso.
Livestock rearing is an important dry season practice for their counterparts in Burkina Faso. Yet because of legal boundaries, these farmers do not have the same freedom to access the wealthier markets in southern Ghana. Consequently, Oribili farmers provide much needed liquidity in the Burkina Faso markets, but do so by buying cheaper and selling higher, thus earning an arbitrage profit. The only limit to this arbitrage profit is the carrying capacity of their vehicles and the liquidity in hand.
With increased rainfall variability, the farmers in Orbili will continue to guess the arrivals of the rains to plan sowing. But in the meantime, every Wednesday, farmers with cash in their pockets will make the 20km journey to Burkina Faso for livestock purchases, others will go to their river side gardens in the morning to water their precious stocks of peppers, okra and garden eggs, and the younger and stronger lot will look for work on construction sites in the south.
This is adaptation in action. But come May, when the rains finally arrive, they will all quit their diversification strategies and head back to their farms in Orbili. After all, they are farmers at heart.
Abrar Chaudhury and Chase Sova are doctoral students at University of Oxford’s School of Geography and the Environment. They are members of the Systemic Integrated Adaptation (SIA) project. The SIA project is part of the CCAFS' Theme One Research Programme:Adaptation to Progressive Climate Change and is housed within Oxford University's Environmental Change Institute. To get more updates from our research teams follow us on Facebook, and Twitter @Cgiarclimate and you can also follow the SIA team on Facebook