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The economic gains from breaking boundaries: Reformulating index insurance zones to maximize lower tail dependence

Author

Listed:
  • Estefania-Salazar, Enrique
  • Carter, Michael R.
  • Iglesias, Eva
  • Escribano, Álvaro

Abstract

Index insurance intended to help low-wealth households manage risk is hampered by downside basis risk, meaning that the insured suffers a loss, but the insurance index fails to signal a loss. Existing index insurance contracts use statisticallyad hoc administrative boundaries to demarcate insurance zones. We develop an algorithm that creates zones that maximize lower tail dependence amongst individual units included in each zone. Breaking boundaries in this way minimizes downside basis risk. Using data from a satellite-based index insurance program in Kenya, we show that replacing administrative with optimized zones can as much as triple the value of insurance using an expected utility-based metric of insurance quality. Robustness tests indicate that this finding is not a result of overfitting the data and we also obtain similar results when applying the same approach to other areas in the Horn of Africa.

Suggested Citation

  • Estefania-Salazar, Enrique & Carter, Michael R. & Iglesias, Eva & Escribano, Álvaro, 2027. "The economic gains from breaking boundaries: Reformulating index insurance zones to maximize lower tail dependence," Journal of Development Economics, Elsevier, vol. 184(C).
    • Handle: RePEc:eee:deveco:v:184:y:2027:i:c:s0304387826001963
    DOI: 10.1016/j.jdeveco.2026.103913
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    Keywords

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    JEL classification:

    • G52 - Financial Economics - - Household Finance - - - Insurance
    • O12 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Microeconomic Analyses of Economic Development
    • O13 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Agriculture; Natural Resources; Environment; Other Primary Products

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