Optimal Risk Pooling for Area-Yield Insurance Design: A Machine-Learning Approach

40 Pages Posted: 16 Dec 2019

See all articles by Yanbin Xu

Yanbin Xu

Nanyang Technological University (NTU)

Guangming Pan

Nanyang Technological University (NTU)

Wenjun Zhu

Nanyang Business School, Nanyang Technological University

Date Written: November 29, 2019

Abstract

Area-yield insurance has gained much attention in acdademy and practice due to its capability of addressing information asymmetry and data limitation, as well as its low administrative cost. However, by its index insurance nature, area-yield insurance suffers the problem of basis risk. The objective of this paper is to reduce the basis risk of area-yield crop insurance by finding the optimal risk pooling using machine learning algorithms. Two clustering algorithms, including the K-means algorithm and the Gaussian Mixture Model (GMM) optimized with Expectation-Maximization (EM) algorithm, are investigated and compared in searching alternative grouping methods. Five model selection algorithms are utilized to determine the optimized number of risk pools by taking the weather, location, and historical yield information into consideration. The five model selection algorithms are Elbow Point of Within Group Sum of Squares (WSS), validity measurement, Average Silhouette Index, Gap Statistic, and Weighted Stochastic Block Model (WSBM). Finally, the proposed optimal risk pooling algorithms are empirically tested and cross-compared with the U.S. corn production and weather data from 12 States in the Midwest region.

Keywords: Area-Yield Insurance, weather risk, machine learning, risk pooling, K-means, Gaussian Mixture Model

JEL Classification: C1, C8, Q5

Suggested Citation

Xu, Yanbin and Pan, Guangming and Zhu, Wenjun, Optimal Risk Pooling for Area-Yield Insurance Design: A Machine-Learning Approach (November 29, 2019). Available at SSRN: https://ssrn.com/abstract=3495365 or http://dx.doi.org/10.2139/ssrn.3495365

Yanbin Xu

Nanyang Technological University (NTU) ( email )

S3 B2-A28 Nanyang Avenue
Singapore, 639798
Singapore

Guangming Pan

Nanyang Technological University (NTU) ( email )

S3 B2-A28 Nanyang Avenue
Singapore, 639798
Singapore

Wenjun Zhu (Contact Author)

Nanyang Business School, Nanyang Technological University ( email )

50 Nanyang Avenue
Singapore, 639798
Singapore
(65) 6592-1859 (Phone)

HOME PAGE: http://sites.google.com/view/wenjun-zhu

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