Experimental Evidence on the Effect of Insurance on Producer Behavior in the Face of Price Risk

Abstract

Production risks can be caused by indirect factors such as weather, and direct factors such as price. Failure of constructing resilient financial markets to mitigate these price risks, can cause damaging and lasting impacts to the economy. This study contributes to the literature on risk and uncertainty by testing the effect of insurance, both full and partial, on producer behavior in the face of price risk. I use an experimental setting to address the relationship between behavior under price risk uncertainty, and how that behavior is shaped in the presence of insurance. I find that participants do not adjust their production choices in situations of price risk. When provided with insurance, they do increase production significantly, and reduce it when it is unavailable. The positive effect of full insurance, is higher than that of partial insurance. By comparing the effect of partial, and full insurance, I find evidence for moral hazard.