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Basis Risk and Compound-Risk Aversion: Evidence from a WTP Experiment in Mali

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  • Elabed, Ghada
  • Carter, Michael R.

Abstract

We present a novel way to understand the low uptake of index insurance using the interlinked concepts of ambiguity and compound-lottery aversion. Noting that the presence of basis risk makes index insurance a compound lottery, we derive an expression of the willingness to pay (WTP) to eliminate basis risk. Empirically, we implement this WTP measure using framed eld experiments with cotton farmers in Southern Mali. In this sample, 57% of the surveyed farmers reveal themselves to be compound-risk averse to varying degrees. Using the distributions of compound-risk aversion and risk aversion in this population, we simulate the impact of basis risk on the demand for an index insurance contract. Compound-risk aversion decreases the demand for index insurance relative to what it would be if individuals had the same degree of risk aversion but were compound-risk neutral. In addition, demand declines more steeply as basis risk increases under compound-risk aversion than it does under risk neutrality. Our results highlight the importance of designing contracts with minimal basis risk if potential buyers are compound-risk averse.

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Bibliographic Info

Paper provided by Agricultural and Applied Economics Association in its series 2013 Annual Meeting, August 4-6, 2013, Washington, D.C. with number 150353.

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Date of creation: 2013
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Handle: RePEc:ags:aaea13:150353

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Related research

Keywords: Index Insurance; Risk and Uncertainty; Compound Risk; Ambiguity; Field Experiments; International Relations/Trade; Research Methods/ Statistical Methods; Risk and Uncertainty;

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  1. Galarza, Francisco B. & Carter, Michael R., 2010. "Risk Preferences and Demand for Insurance in Peru: A Field Experiment," 2010 Annual Meeting, July 25-27, 2010, Denver, Colorado 61871, Agricultural and Applied Economics Association.
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Cited by:
  1. Jean Philippe Platteau & Darwin Ugarte Ontiveros, 2013. "Understanding and Information Failures in Insurance: Evidence from India," Development Research Working Paper Series 07/2013, Institute for Advanced Development Studies.

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