Exploring the link between insurance behavior and trust in markets

We propose a model, called β-RDEu (Rank Dependent Expected Utility), that explains how distrust in an exchange relationship can lead to zero demand for a good or service, even when it is heavily subsidized. If an agent’s preferences, as estimated in a decontextualized environment (i.e., without distrust), are represented by a function V, then the β-RDEu function for a contract l is defined as βu(w_n) + (1 − β)V (l), and represents the agent’s preferences in a market environment where distrust may arise. The parameter β captures the agent’s level of distrust, and the wealth level wn represents an outcome excluded by the contractual relationship but considered plausible by a distrustful agent. We characterize the β-RDEu utility through a set of assumptions about preferences, and then apply the model to agricultural insurance demand. The main prediction is that agricultural insurance demand can be zero at any price if the agent is sufficiently distrustful, even though the contract provides positive net utility when assessed solely through the function V. We discuss the introduction of behavioral interventions aimed at either leveraging or reducing distrust to increase the adoption rate of agricultural insurance products. In particular, we propose a procedure to estimate the distribution of the β parameter within a population, in order to show how knowledge of this distribution can enhance the effectiveness of a subsidy.