Optimal Demand for Index Insurance Under Basis Ambiguity

Abstract

This study examines how basis ambiguity influences the demand for index insurance. Ambiguity is introduced into the statistical relationship between the loss and the index because they are more difficult to guess than the occurrence of the loss and the index individually. Basis ambiguity lowers the demand for index insurance and increases the threshold to hold the index insurance. This is a possible explanation for the very low demand and participation in index insurance. Further, we consider how changes in ambiguity and ambiguity aversion influence the demand.

Keywords: Ambiguity aversion, Insurance demand, Statistical relationship

JEL Classification: D81, D91, G52