Arjan Verschoor, University of East Anglia

"Informal Risk Sharing and Demand for Index Insurance: Experimental Evidence from Rural Uganda"

Abstract

Index insurance holds promise for smallholder farmers in developing countries but its value is limited by basis risk: the imperfect correlation between the index and actual losses. Informal sharing of risk may complement index insurance and raise demand, or it may substitute for it and lower demand. Theory shows that the size of the net effect is ambiguous but that the isolated effect of basis risk sharing on the demand for index insurance is unambiguously positive. We designed an experiment to study the effect of informal risk sharing on demand for index insurance and implemented it among Ugandan farmers. We find that demand for index insurance responds negatively to risk sharing, which suggests that the latter crowds out the former. We also find that farmers share a greater proportion of losses when these are associated with basis risk but that, contrary to theory, basis risk sharing paradoxically lowers demand for index insurance. We discuss the strong local sharing norms and behavioural motives that may help interpret this finding.

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