Why Not Insure Prices? Experimental Evidence from Peru

In a competitive market, a profit-maximizing producer's total revenue is determined both by the quantity of output she chooses to produce and by the price at which she can sell that output. Of these two variables, only output is in part or wholly within the producer's control, price being entirely determined by market forces. Given that, it is puzzling that the literature studying the effects of providing insurance to producers in low- and middle-income countries has ignored price risk entirely, focusing instead on insuring output. We run an artefactual lab-in-the-field experiment in Peru to look at the effects of insurance against output price risk on production. We randomize the order of three games: (i) a baseline game in which price risk is introduced at random, (ii) the baseline game to which we add mandatory insurance against price risk sold at an actuarially fair premium, and (iii) the baseline game to which we add voluntary insurance against price risk sold at the actuarially fair premium, but for which we offer a random 0-, 50- or 100% discount to exogenize take-up. Our results show that, on average, (i) price risk does not significantly change production relative to price certainty and (ii) neither does the provision of compulsory insurance against price risk, but the introduction of voluntary price risk (iii) causes the average producer on the market to produce more in situations of price risk than in situations of price certainty, and (iv) causes the average producer on the market to produce more in situations of price certainty than in cases where there is no insurance or where insurance is mandatory. When looking only at situations where there is price risk, (v) this is due almost entirely to the insurance rather than to selection into purchasing the insurance. Our findings further suggest that (vi) even in the absence of the discount, the insurance against price risk would have a large (i.e., 70%) take-up rate.(This abstract was borrowed from another version of this item.)