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

Francesca de Nicola, Ruth Vargas Hill, and Miguel Robles

Agricultural income in low income countries is subject to many risks, such as weather un-certainty, pests and disease. Much of this risk remains uninsured by existing risk managementtools and this uninsured risk constraints investment. In this paper we examine the potential bene ts of three nancial products-weather index insurance, savings accounts, and insured agri-cultural loans-that could improve a household's ability to manage agricultural risks to answer the question of what nancial instruments do farmers really need? We develop and estimate a dynamic stochastic model that quanti es the impact of these three products on consumption, investment and welfare. The parameters of the model are calibrated with data from farmers in Ethiopia All three instruments o er welfare gains to farmers. The gains from index insurance and insured credit are particularly high, but basis risk mutes these gains. When basis risk is high the investment response to index insurance is weaker which results in lower consumption gains. Combined with higher consumption volatility, this results in lower welfare. However, we nd that improved access to savings limits the negative e ects of basis risk, suggesting that an approach that develops multiple nancial instruments for farmers may be better than an approach focused on one instrument alone.


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