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A Theory of Rational Demand for Index Insurance

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  • Daniel J. Clarke

Abstract

Rational demand for hedging products, where there is a risk of contractual nonperformance, is fundamentally different to that for indemnity insurance.� In particular, optimal demand is zero for infinitely risk averse individuals, and is nonmonotonic in risk aversion, wealth and price.� For commonly used families of utility functions, demand is hump-shaped in the degree of risk aversion when the price is actuarially unfair, first increasing then decreasing, and either decreasing or decreasing-increasing-decreasing in risk aversion when the price is actuarially favourable.� For a given belief, upper bound are derived for the optimal demand from risk averse and decreasing absolute risk averse decision makers.� The apparently low level of demand for consumer hedging instruments, particularly from the most risk averse, is explained as a rational response to deadweight costs and the risk of countractual nonperformance.� A numerical example is presented for maize in a developing county which suggests that some unsubsidised weather derivatives, currently being designed for and marketed to poor farmers, may in fact be poor products, in that objective financial advice would recommend�low or zero purchase from all risk averse expected utility maximisers.

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Bibliographic Info

Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 572.

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Date of creation: 01 Oct 2011
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Handle: RePEc:oxf:wpaper:572

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Keywords: Index insurance; Derivative; Basis risk; Hedge; Microinsurance;

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References

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  1. Mahul, Olivier & Verma, Niraj & Clarke, Daniel J., 2012. "Improving farmers'access to agricultural insurance in India," Policy Research Working Paper Series 5987, The World Bank.
  2. Hongbin Cai & Yuyu Chen & Hanming Fang & Li-An Zhou, 2009. "Microinsurance, Trust and Economic Development: Evidence from a Randomized Natural Field Experiment," NBER Working Papers 15396, National Bureau of Economic Research, Inc.
  3. Xavier Giné & Robert Townsend & James Vickery, 2007. "Statistical Analysis of Rainfall Insurance Payouts in Southern India," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, Agricultural and Applied Economics Association, vol. 89(5), pages 1248-1254.
  4. Carter, Michael R. & Galarza, Francisco & Boucher, Stephen, 2007. "Underwriting area-based yield insurance to crowd-in credit supply and demand," MPRA Paper 24326, University Library of Munich, Germany.
  5. Shawn Cole & Xavier Gine & Jeremy Tobacman & Petia Topalova & Robert Townsend & James Vickery, 2013. "Barriers to Household Risk Management: Evidence from India," American Economic Journal: Applied Economics, American Economic Association, American Economic Association, vol. 5(1), pages 104-35, January.
  6. Daniel J. Clarke, 2011. "Reinsuring the Poor: Group Microinsurance Design and Costly State Verification," Economics Series Working Papers 573, University of Oxford, Department of Economics.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. What have we learned from all the agricultural microinsurance pilots?
    by Daniel Clarke in The CSAE Blog on 2012-11-16 11:50:00
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
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Cited by:
  1. Hans P. Binswanger-Mkhize, 2012. "Is There Too Much Hype about Index-based Agricultural Insurance?," Journal of Development Studies, Taylor & Francis Journals, Taylor & Francis Journals, vol. 48(2), pages 187-200, February.
  2. Liu, Yanyan & Chen, Kevin Z. & Hill, Ruth Vargas & Xiao, Chengwei, 2013. "Borrowing from the insurer: An empirical analysis of demand and impact of insurance in China:," IFPRI discussion papers, International Food Policy Research Institute (IFPRI) 1306, International Food Policy Research Institute (IFPRI).
  3. A. Mushfiq Mobarak & Mark Rosenzweig, 2012. "Selling Formal Insurance to the Informally Insured," Working Papers id:4777, eSocialSciences.
  4. Daniel J. Clarke, 2011. "Reinsuring the Poor: Group Microinsurance Design and Costly State Verification," Economics Series Working Papers 573, University of Oxford, Department of Economics.
  5. Gharad Bryan & Shyamal Chowdhury & Ahmed Mushfiq Mobarak, 2014. "Under-investment in a Profitable Technology: The Case of Seasonal Migration in Bangladesh," NBER Working Papers 20172, National Bureau of Economic Research, Inc.
  6. Clarke, Danielle & Das, Narayan C. & de Nicola, Francesca & Hill, Ruth Vargas & Kumar, Neha & Mehta, Parendi, 2012. "The value of customized insurance for farmers in rural Bangladesh:," IFPRI discussion papers, International Food Policy Research Institute (IFPRI) 1202, International Food Policy Research Institute (IFPRI).
  7. Mahul, Olivier & Verma, Niraj & Clarke, Daniel J., 2012. "Improving farmers'access to agricultural insurance in India," Policy Research Working Paper Series 5987, The World Bank.
  8. de Janvry, A. & Dequiedt, V. & Sadoulet, E., 2014. "The demand for insurance against common shocks," Journal of Development Economics, Elsevier, Elsevier, vol. 106(C), pages 227-238.
  9. Matsuda, Ayako & Kurosaki, Takashi & Sawada, Yasuyuki, 2013. "Rainfall and Temperature Index Insurance in India: Project Documentation," PRIMCED Discussion Paper Series, Institute of Economic Research, Hitotsubashi University 34, Institute of Economic Research, Hitotsubashi University.
  10. Robert M. Townsend & Shawn Cole & Jeremy Tobacman & Xavier Gine & James Ian Vickery & Petia Topalova, 2012. "Barriers to Household Risk Management," IMF Working Papers 12/195, International Monetary Fund.
  11. Clarke, Daniel J. & Hill, Ruth Vargas, 2013. "Cost-benefit analysis of the african risk capacity facility:," IFPRI discussion papers, International Food Policy Research Institute (IFPRI) 1292, International Food Policy Research Institute (IFPRI).
  12. Vieider, Ferdinand M. & Truong, Nghi & Martinsson, Peter & Pham Khanh Nam & Martinsson, Peter, 2013. "Risk preferences and development revisited: A field experiment in Vietnam," Discussion Papers, WZB Junior Research Group Risk and Development SP II 2013-403, Social Science Research Center Berlin (WZB).
  13. Clarke, Daniel J. & Mahul, Olivier & Rao, Kolli N. & Verma, Niraj, 2012. "Weather based crop insurance in India," Policy Research Working Paper Series 5985, The World Bank.
  14. Dercon, Stefan & Hill, Ruth Vargas & Clarke, Daniel & Outes-Leon, Ingo & Seyoum Taffesse, Alemayehu, 2014. "Offering rainfall insurance to informal insurance groups: Evidence from a field experiment in Ethiopia," Journal of Development Economics, Elsevier, Elsevier, vol. 106(C), pages 132-143.
  15. Boucher, Steve & Delpierre, Matthieu, 2013. "The Impact of Index-Based Insurance on Informal Risk-Sharing Networks," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C., Agricultural and Applied Economics Association 150440, Agricultural and Applied Economics Association.
  16. Elabed, Ghada & Carter, Michael R., 2013. "Basis Risk and Compound-Risk Aversion: Evidence from a WTP Experiment in Mali," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C., Agricultural and Applied Economics Association 150353, Agricultural and Applied Economics Association.
  17. Eling, Martin & Pradhan, Shailee & Schmit, Joan T., 2013. "The Determinants of Microinsurance Demand," Working Papers on Finance, University of St. Gallen, School of Finance 1308, University of St. Gallen, School of Finance.

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