This paper analyzes the role of drought frequency in farmers’ demand for index insurance in developing countries.
In a model derived from Doherty and Schlessinger (1990), we show that the demand for insurance is an inverted U curve function of drought frequency. We further show that both loading factor and basis risk hinder insurance demand for high drought frequency. To assess the empirical relevance of such effects, we led an insurance field experiment in Burkina Faso with 205 farmers.
Analysis of revealed insurance demand for different frequencies of insured drought, different levels of basis risks and different loading factors through incentivized lotteries choices confirms that insurance demand decreases with basis risk and the loading factor. More importantly we empirically establish that increasing drought frequency lead to lower insurance demand.