How to cope with systemic risk in index‐based crop insurance

Tempie Samok, Shanae Canterberry

Abstract


According to the previous experiment, the implementation of index‐based crop insurance is often impeded by the existence of systemic risk of insured losses. In this article,we assess the effectiveness of two strategies for coping with systemic risk in terms of providing a optized method in coping with systemic risk. In oder to achieve that, the analysis is conducted in an equilibrium pricing framework which can determine the optimal price of the insurance and the number of traded contracts. In addition, we also explore the role of basis risk and risk aversion of market agents. The model presented in this article can be  applied to a hypothetical area yield insurance for rice producers in northeast China. Resultsindicate 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.

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