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Precipitation or water capacity indices? An analysis of the benefits of alternative underlyings for index insurance

  • Kellner, Ulla
  • Musshoff, Oliver

Eastern Germany is often hit by drought causing income risk for crop farmers. Index-based risk management instruments could help crop farmers to reduce their farm income risk. Such instruments have some important advantages over damage-based insurance, like e.g. less moral hazard and adverse selection. At the same time they typically have a high level of basis risk. Up to now, mainly precipitation-based weather derivatives have been discussed as an appropriate risk management instrument for farmers in Germany. As a potentially more effective alternative, we propose water capacity-based index insurance. In order to show the benefits of a precipitation-based and water capacity-based index insurance, several contract designs are compared. Using a whole farm risk program planning approach, we show that for an average agricultural producer in Eastern Germany water capacity-based index insurance offers greater benefits than precipitation-based index insurance.

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Article provided by Elsevier in its journal Agricultural Systems.

Volume (Year): 104 (2011)
Issue (Month): 8 (October)
Pages: 645-653

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Handle: RePEc:eee:agisys:v:104:y:2011:i:8:p:645-653
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