The Demand for Specialty-Crop Insurance: Adverse Selection and Moral Hazard



E[U(π )] = u() + (i∕2)h εφ(α)dαU "(π) + E[r3ε],
El

Where φ is the density function of a the random error term. In order to determine the “price of
risk”, Stiglitz and Newbery (1984) compare the mean level of income to its certainty equivalent,
or the certain level of income that generates a utility level equal to the expected utility of a
random income:
E[U(n)] = U(n) . Using this result, the price of risk is then the difference
between the mean and certainty equivalent levels of income: p =
π - π Expanding the utility of
the certainty equivalent income gives an expression in terms of the mean income and the price of

U(π) = U(π - ρ) = U(π) - ρU'(π) + r2(ρ),

risk:

where again the higher order remainder terms go to zero with the price of risk. Setting (5) equal

ρ = - ( 1/2)


' var( ε)U "( ) )
< U '() ;

to (4) and solving for the price of risk gives:

Several conclusions follow from this result. Most important, under the assumption of
decreasing absolute risk aversion (DARA), an increase in the variance of output, and, hence
income, causes the price of risk to rise. Therefore, production inputs that cause the variance of
output to rise are likely to cause the willingness to pay for insurance to rise, while risk-reducing
inputs reduce the willingness to pay for insurance. Ramaswami (1993) provides a similar result in



More intriguing information

1. Empirical Calibration of a Least-Cost Conservation Reserve Program
2. Tax Increment Financing for Optimal Open Space Preservation: an Economic Inquiry
3. The name is absent
4. Uncertain Productivity Growth and the Choice between FDI and Export
5. The name is absent
6. The name is absent
7. Computational Batik Motif Generation Innovation of Traditi onal Heritage by Fracta l Computation
8. The name is absent
9. Creating a 2000 IES-LFS Database in Stata
10. Natural hazard mitigation in Southern California
11. DISCUSSION: POLICY CONSIDERATIONS OF EMERGING INFORMATION TECHNOLOGIES
12. The name is absent
13. The name is absent
14. The name is absent
15. TRADE NEGOTIATIONS AND THE FUTURE OF AMERICAN AGRICULTURE
16. Heterogeneity of Investors and Asset Pricing in a Risk-Value World
17. European Integration: Some stylised facts
18. The name is absent
19. Quality practices, priorities and performance: an international study
20. The name is absent