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On the role of probability weighting on WTP for crop insurance with and without yield skewness

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  • Douadia, Bougherara
  • Laurent, Piet

Abstract

A growing number of studies in finance and economics seek to explain insurance choices us- ing the assumptions advanced by behavioral economics. One recent example in agricultural economics is the use of cumulative prospect theory (CPT) to explain farmer choices regarding crop insurance coverage levels (Babcock, 2015). We build upon this framework by deriving willingness to pay (WTP) for insurance programs under alternative assumptions, thus extend- ing the model to incorporate farmer decisions regarding whether or not to purchase insurance. Our contribution is twofold. First, we study the sensitivity of farmer WTP for crop insurance to the inclusion of CPT parameters. We find that loss aversion and probability distortion in- crease WTP for insurance while risk aversion decreases it. Probability distortion in losses plays a particularly important role. Second, we study the impact of yield distribution skewness on farmer WTP assuming CPT preferences. We find that WTP decreases when the distribution of yields moves from negatively- to positively-skewed and that the combined effect of proba- bility weighting in losses and skewness has a large negative impact on farmer WTP for crop insurance.

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  • Douadia, Bougherara & Laurent, Piet, 2018. "On the role of probability weighting on WTP for crop insurance with and without yield skewness," Working Papers SMART 18-08, INRAE UMR SMART.
  • Handle: RePEc:rae:wpaper:201808
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    2. Hongli Feng & Xiaodong Du & David A. Hennessy, 2020. "Depressed demand for crop insurance contracts, and a rationale based on third generation Prospect Theory," Agricultural Economics, International Association of Agricultural Economists, vol. 51(1), pages 59-73, January.

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    More about this item

    Keywords

    crop insurance; cumulative prospect theory; premium subsidy; Skewnes;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • Q10 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - General
    • Q12 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Micro Analysis of Farm Firms, Farm Households, and Farm Input Markets
    • Q18 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Agricultural Policy; Food Policy; Animal Welfare Policy

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