Interplay among credit, insurance and savings for farmers in developing countries

Agricultural income in low income countries is subject to many risks, much of which is unin- sured. In this paper we examine the potential benets of three nancial products -weather index insurance, savings accounts, and insured agricultural loans- that could improve a household's ability to manage agricultural risks. We develop and estimate a dynamic stochastic model that explores the relative benets of these three products by quantifying their impact on consump- tion, investment and welfare. The parameters of the model are calibrated with data from farmers in Ethiopia. All three instruments oer welfare gains to farmers, particularly index insurance. Index insurance oers larger welfare gains to poorer households, even though demand for index insurance is initially increasing in wealth. However, index insurance oers welfare gains only when well-priced and characterized by low basis-risk. A simple savings account oers larger welfare gains for many households when index insurance is expensive or of poor quality. Savings and insurance are substitutes, but oering both allows households to realize additional welfare gains, particularly when basis risk is high. Our results highlight the importance of considering the relative welfare impact of multiple nancial contracts, particularly in settings where one contract is highly priced or of low quality.

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Francesca de Nicola and Ruth Vargas Hill
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