Risk Sharing and the Demand for Insurance: Theory and Experimental Evidence from Ethiopia

Households, organisations and governments commonly engage in risk sharing. The residual risk, however, is often considerable. In response, many policy makers consider the introduction of parametric or index insurance. This raises the question of how demand for insurance depends on the extent of pre-existing risk sharing. We contribute to the literature in two ways. First, we present a simple model to analyse demand for both standard indemnity insurance and index insurance in the presence of risk sharing. Second, we conduct an artefactual field experiment with Ethiopian farmers, in which the predictions of the theoretical framework are borne out.