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Crop Insurance: The Relationship Between Indemnity Price And Expected Output Price

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  • Charles E. Hyde

Abstract

Crop insurance contracts typically constrain the choice of price at which indemnification occurs to be less than the expected output price. This restriction is first analysed assuming only risk‐averse farmers, and yield and price uncertainty. General conditions under which the optimal price selection is bounded above by the expected output price are found to be difficult to derive. The results of numerical simulations based on a range of different utility functional forms are presented, and a strong tendency is observed for the optimal price selection to be bounded from below by the expected output price. The effect of increasing output price variability on the optimal price selection is also considered. The simulation results suggest that the optimal price selection is often non‐increasing with a mean‐preserving spread of the output price distribution. Lastly, it is noted that even in the presence of hidden‐action moral hazard, if the incentives for shirking are not too high, the constraint that price selections be lower than the expected output price may still be binding.

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  • Charles E. Hyde, 1996. "Crop Insurance: The Relationship Between Indemnity Price And Expected Output Price," Journal of Agricultural Economics, Wiley Blackwell, vol. 47(1‐4), pages 236-246, January.
  • Handle: RePEc:bla:jageco:v:47:y:1996:i:1-4:p:236-246
    DOI: 10.1111/j.1477-9552.1996.tb00687.x
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    1. HOLMSTROM, Bengt, 1979. "Moral hazard and observability," LIDAM Reprints CORE 379, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    2. Jerry R. Skees & Michael R. Reed, 1986. "Rate Making for Farm-Level Crop Insurance: Implications for Adverse Selection," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 68(3), pages 653-659.
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    4. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
    5. Townsend, Robert M., 1979. "Optimal contracts and competitive markets with costly state verification," Journal of Economic Theory, Elsevier, vol. 21(2), pages 265-293, October.
    6. Robert G. Chambers, 1989. "Insurability and Moral Hazard in Agricultural Insurance Markets," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 71(3), pages 604-616.
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    Cited by:

    1. Charles E. Hyde & James A. Vercammen, 1997. "Costly Yield Verification, Moral Hazard, And Crop Insurance Contract Form," Journal of Agricultural Economics, Wiley Blackwell, vol. 48(1‐3), pages 393-407, January.

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