Index Insurance, Probabilistic Climate Forecasts, and Production

Miguel Carriquiry, Daniel E. Osgood
March 2008  [08-WP 465]

Index insurance and probabilistic seasonal forecasts are becoming available in developing countries to help farmers manage climate risks in production. Although these tools are intimately related, work has not been done to formalize the connections between them. We investigate the relationship between the risk management tools through a model of input choice under uncertainty, forecasts, and insurance. While it is possible for forecasts to undermine insurance, we find that when contracts are appropriately designed, there are important synergies between forecasts, insurance, and effective input use. Used together, these tools overcome barriers preventing the use of imperfect information in production decision making.

Keywords: basis risk, climate forecast, index insurance, input decisions, insurance, risk management.

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