How Does Risk Management Influence Production Decisions? Evidence from a Field Experiment

Weather is a key source of income risk
for many firms and households, particularly in emerging
market economies. This paper uses a randomized controlled
trial approach to study how an innovative risk management
instrument for hedging rainfall risk affects production
decisions among a sample of Indian agricultural firms. The
analysis finds that the provision of insurance induces
farmers to shift production toward higher-return but
higher-risk cash crops, particularly among more-educated
farmers. The results support the view that financial
innovation may help mitigate the real effects of uninsured
production risk. In a second experiment, the study elicits
willingness to pay for insurance policies that differ in
their contract terms, using the Becker-DeGroot-Marshak
mechanism. Willingness-to-pay is increasing in the actuarial
value of the insurance, but substantially less than
one-for-one, suggesting that farmers' valuations are
inconsistent with a fully rational benchmark.