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How Should We Value Agricultural Insurance Contracts

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Author Info

  • Myers, Robert J.
  • Liu, Yanyan
  • Hanson, Steven D.

Abstract

We argue that existing agricultural insurance valuation models are limited either because they are not complete equilibrium models that price the non-diversifiable risk involved in issuing insurance contracts, or they assume complete markets which appears at odds with most applications of agricultural insurance. We also propose two new incomplete market models and derive an insurance valuation formula for each under the assumption of constant relative risk aversion preferences and lognormally distributed random variables. The two models differ in the way they treat trade in insurance contracts, with one model allowing insurers and insureds to trade freely on a liquid secondary market, while the other requires insurance firms to act as brokers between insureds (farmers) and the capital market (those who bear the non-diversifiable risk). The two models lead to different valuation formulas and several interesting insights are obtained by comparing our valuation formulas with those used in the existing literature.

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Bibliographic Info

Paper provided by American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association) in its series 2005 Annual meeting, July 24-27, Providence, RI with number 19561.

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Date of creation: 2005
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Handle: RePEc:ags:aaea05:19561

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Keywords: Risk and Uncertainty;

References

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  1. Constantinides, George M & Duffie, Darrell, 1996. "Asset Pricing with Heterogeneous Consumers," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 219-40, April.
  2. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  3. Shihong Yin & Calum G. Turvey, 2003. "The Pricing of Revenue Assurance: Comment," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 85(4), pages 1062-1065.
  4. Calum G. Turvey & Vincent Amanor-Boadu, 1989. "Evaluating Premiums for a Farm Income Insurance Policy," Canadian Journal of Agricultural Economics/Revue canadienne d'agroeconomie, Canadian Agricultural Economics Society/Societe canadienne d'agroeconomie, vol. 37(2), pages 233-247, 07.
  5. Mark Rubinstein., 1994. "Implied Binomial Trees," Research Program in Finance Working Papers RPF-232, University of California at Berkeley.
  6. John Duncan & Robert J. Myers, 2000. "Crop Insurance under Catastrophic Risk," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 82(4), pages 842-855.
  7. Richards, Timothy J. & Manfredo, Mark R. & Sanders, Dwight R., 2004. "Pricing Weather Derivatives," Working Papers 28536, Arizona State University, Morrison School of Agribusiness and Resource Management.
  8. Rubinstein, Mark, 1994. " Implied Binomial Trees," Journal of Finance, American Finance Association, vol. 49(3), pages 771-818, July.
  9. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  10. Mario J. Miranda & Joseph W. Glauber, 1997. "Systemic Risk, Reinsurance, and the Failure of Crop Insurance Markets," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 79(1), pages 206-215.
  11. Jeffrey R. Stokes & William I. Nayda, 2003. "The Pricing of Revenue Assurance: Reply," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 85(4), pages 1066-1069.
  12. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  13. Jeffrey R. Stokes & William I. Nayda & Burton C. English, 1997. "The Pricing of Revenue Assurance," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 79(2), pages 439-451.
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Cited by:
  1. Calum G. Turvey, 2010. "Biography: Kiyosi Itô and his influence on the study of agricultural finance and economics," Agricultural Finance Review, Emerald Group Publishing, vol. 70(1), pages 5-20, May.
  2. Xu, Wei & Odening, Martin & Musshoff, Oliver, 2007. "Indifference Pricing of Weather Insurance," 101st Seminar, July 5-6, 2007, Berlin Germany 9267, European Association of Agricultural Economists.

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