DESIGNING OPTIMAL CROP REVENUE INSURANCE

The optimal crop revenue insurance contract is designed from recent developments in the theory of insurance economics under incomplete markets. The message is two-fold. Firstly, when the indemnity schedule is contingent onindividual price and individual yield, the optimal contract depends only on the individual gross revenue. Secondly, this policy is shown to fail if the indemnity function is based on aggregate price and/or aggregate yield. Aclosed-form solution, in which basis risks are ignored, is proposed. It differs from actual revenue insurance programs proposed to the U.S. farmers. When insurance and capital markets are unbiased, it can be replicated with existingcrop yield and revenue insurance policies and hedging contracts if the decision variables are not constrained. The impact of yield and price basis risks on the form of the optimal crop revenue insurance contract is examined and a closed-form solution is derived.