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Coping with systemic risk in index-based crop insurance
Article first published online: 7 SEP 2012
© 2012 International Association of Agricultural Economists
Volume 44, Issue 1, pages 1–13, January 2013
How to Cite
Shen, Z. and Odening, M. (2013), Coping with systemic risk in index-based crop insurance. Agricultural Economics, 44: 1–13. doi: 10.1111/j.1574-0862.2012.00625.x
- Issue published online: 8 JAN 2013
- Article first published online: 7 SEP 2012
- Received 01 December 2011; received in revised form 29 May 2012; accepted 27 July 2012
- Crop insurance;
- Systemic risk;
- Risk pooling;
- Equilibrium pricing
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 higher insurance premiums. 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.