The Impact of Weather Insurance on Consumption, Investment, and Welfare
Weather variations crucially act the wellbeing of farmers in developing countries yet weather insurance is rather rare. I develop and estimate a dynamic stochastic optimization model to assess the impact of weather insurance on the consumption, investment, and welfare for farmers in developing countries. The parameters of the model are pinned down with a combination of calibration and structural estimation using data from Malawi. Contrary to some past work, I find that weather insurance has the potential to provide substantial welfare gains equivalent to an almost 17% permanent increase in consumption. These gains can be magnified especially for very poor households by contemporaneously extending credit to finance the additional desired investment. In an extension of the model I also show that weather insurance can allow for the adoption of riskier but more-productive improved seeds, further boosting farmers' welfare. Finally, I explore the extent to which the interplay with other uninsured risks, the presence of basis risk, and a loading factor on the insurance premium may lower the welfare gains from weather insurance, and lead to low take-up as is often observed empirically.