EFFECTS OF SMALLHOLDER DIVERSIFICATION ON RURAL HOUSEHOLD FOOD SECURITY IN KENYA ABSTRACT Market-oriented economic reforms are now at least 20 years old in most of Sub-Saharan Africa (SSA). Prior to these reforms, most economies were fettered with far-ranging limits on investment, private sector trade, and other initiatives, and on the free movement of agricultural products over space. Kenya is a prime example of these earlier policies, with limits on maize marketing, agricultural inputs marketing and dairy marketing restrictions that were lifted through the reforms. Over this same time, urban populations and rural population densities have increased dramatically, further broadening the scope for trade, and setting off the process of agricultural transformation. In addition, changes in the weather patterns have often affected smallholder agricultural production and consumption decisions. How have the rural farm households been affected by these dramatically different policy, economic and climatic environments, and how have these changes and patterns shaped the welfare of rural households? The effect of smallholder diversification in rural areas is conjectured to be correlated to the agricultural transformation process. In the absence of markets, households are likely to rely solely on own production and they tend to produce mainly for subsistence. As markets begin to function, diversification is likely to increase household income and wealth, but reduce the household’s ability to be food-secure, especially if diversification implies transferring resources from food crops to commercial crops in response to market opportunities. But as markets improve (or as land sizes increase), incomes are likely to be increased through specialization, not diversification, and households no longer have to rely on self-sufficiency to be food-secure. More-specialized households at this stage in the transformation process are likely to be more food-secure. Moreover, studies also show that climate change may affect a farm household choice of income activities that ultimately determine the household welfare. This is more so pertinent in the case of rural household food security. Despite receiving considerable attention in the developing countries, food security continues to be a major challenge. In SSA, for example, it is estimated that about one-quarter of the population, most of whom reside in rural areas where agriculture is the mainstay, are faced with chronic food insecurity. In addition, most rural househlds follow highly diversified agricultural an livelihood portfolios in response to potential risks such as uncertain weather. Yet fewer studies have investigated the effect of smallholder diversification on rural smallholder food security. The purpose of the study is to determine the welfare effects of crop, agricultural and livelihood diversification on farm households food security. It is hypothesized that households diversify income portfolios in order to mitigate the risks to food security. Therefore, the overall objective of this essay is to investigate the welfare effects of agricultural and livelihood diversification at the household level. The specific objectives for the study are to: (a) determine the welfare effects of crop, agricultural and livelihood diversification on rural household food security in the presence of rainfall stress and policy reforms of the 1990s, and (b) examine heterogeneity in household welfare effects of livelihood diversification between groups of households. Using a five-period panel data of 1,243 rural farm households from Kenya collected between 1997 and 2010, this study investigates welfare effects of agricultural and livelihood diversification among smallholder farmers in rural Kenya. Dynamic Panel Data method will be used to investigate the effects of smallholder diversification on rural household food security. The dynamic panel data model is appropriate since it allows for separation of the true state dependence, observed and unobserved heterogeneity. The model assumes no serial correlation of the error term but not independence. Because of potential endogeneity problem caused by, a) the inclusion of the lagged dependent variable and, b) the potential endogeneity of some right-hand side variables, a test for validity of the instrumental variables will be carried out using the Sargan test of overidentifying restrictions. In addition, a test of no serial correlation in the error terms (Arellano-Bond test) will be carried out to ensure correct specification of the model. Household food security (the dependent variable) will be proxied by the amount of maize calories available for consumption at the household per adult equivalent.