Risk Preferences and Demand for Insurance in Peru: A Field Experiment

This paper reports the results of behavioral economic experiments conducted in Peru toexamine the relationship amongst risk preferences, loan take-up, and insurance purchase decisions. This area-based yield insurance can help reduce people's vulnerability to large scalecovariate shocks, and can also lower the loan default probability under extreme negative covariate shocks. In a context of collateralized formal credit markets, we provide suggestive evidencethat insurance may help reduce the fear of losing collateral that prevents potential borrowersfrom taking loans. Framing these experiments to recreate a real life situation, we started witha Baseline Game where subjects had to choose between a fallback production project and anuninsured loan. We then introduced a third project choice--loan with yield insurance (Insurance Game)--which allows us to measure the effect of introducing insurance on the demandfor loans. Overall, more than 50 percent of the subjects are willing to buy insurance in thisinsurance game. Further, controling for the number of peers in the ag network, wealth, andchoices made in the baseline game, we find that the project choice decision is predicted by ajudgment bias known as hot-hand effect, and risk aversion. In the latter case, the shape of therelationship is quadratic, meaning that highly risk averse subjects will prefer switching to therisky, uninsured loan project, while those showing a low and moderate risk aversion will stickto the safer (fallback or insured loan) projects.