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Coping with Systemic Risk in Index-based Crop Insurance

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  • Shen, Zhiwei
  • Odening, Martin

Abstract

The implementation of index-based crop insurance is often impeded by the existence of systemic risk of insured losses. We assess the effectiveness of two strategies for coping with systemic risk: regional diversification and securitization with catastrophe (CAT) bonds. The analysis is conducted in an equilibrium pricing framework which allows the optimal price of the insurance and the number of traded contracts to be determined. We also explore the role of basis risk and risk aversion of market agents. The model is applied to a hypothetical area yield insurance for rice producers in northeast China. If yields in two regions are positively correlated, we find that enlarging the insured area leads to an increasing insurance premium. Unless capital market investors are very risk averse, a CAT bond written on an area yield index outperforms regional diversification in terms of certainty equivalents of both farmers and insurers.

Suggested Citation

  • Shen, Zhiwei & Odening, Martin, 2012. "Coping with Systemic Risk in Index-based Crop Insurance," 123rd Seminar, February 23-24, 2012, Dublin, Ireland 122555, European Association of Agricultural Economists.
  • Handle: RePEc:ags:eaa123:122555
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    References listed on IDEAS

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    Cited by:

    1. Xiaofeng Cao & Ostap Okhrin & Martin Odening & Matthias Ritter, 2015. "Modelling spatio-temporal variability of temperature," Computational Statistics, Springer, vol. 30(3), pages 745-766, September.

    More about this item

    Keywords

    crop insurance; systemic risk; risk pooling; securitization; Risk and Uncertainty; Q11; Q14;

    JEL classification:

    • Q11 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Aggregate Supply and Demand Analysis; Prices
    • Q14 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Agricultural Finance

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