Index Based Insurance in Developing Countries: Rational Neglect?

Microinsurance adoption in developing countries is low, despite its potential to foster economic growth. Recent research is not able to explain the low demand within the neoclassical framework. I contribute to this stream of research by proposing rational as well as boundedly rational explanations for the low attractiveness of microinsurance within a stochastic framework. More precisely, I analyze weather index insurance. My model makes separate predictions for close farmers, whose location is near a weather station, and distant farmers. Results show that the latter ask for less than 50% insurance coverage even under perfect rationality. I extend the model by integrating incorrect beliefs. I can show that a lack of trust reduces insurance demand most for close farmers, while a lack of knowledge about the insurance negatively affects the demand of distant farmers. Moreover, subsidies are more effective for close than for distant farmers.