Description

Abstract: This paper uses a laboratory experiment in Gujarat, India to assess consumers’ relative valuations of savings versus insurance when planning for risky rainfall in an attempt to measure potential demand for a new type of financial product that combines savings and rainfall insurance, which we call a Weather Insured Savings Account (WISA). We first develop a simple model to predict how demand for a WISA would change with its type, defined as the proportion of insurance versus savings that the WISA provides. Our model predicts that there will be an optimal WISA type, and that the utility provided by the WISA will decrease as one moves away from the optimum. We then present the results of a laboratory experiment that attempts to test the predictions of the model and calculate the optimal WISA type. Using a Becker-DeGroot-Marschak (BDM) mechanism, we measure participants’ relative valuations of pure insurance, pure savings, and two intermediate WISA types. Contrary to predictions of our model, we find that a plurality of participants prefer both pure insurance and pure savings to any mixture of the two, and that this preference is most pronounced among those who are more risk averse. We present a number of possible explanations to try to square this result with the neoclassical model, including that these results were driven by confusion over the WISAs or uncertainty over whether future payment would actually be received. We do not find behavior consistent with these explanations. One possible explanation for our results is that subjects exhibited diminishing sensitivity to losses as proposed by prospect theory. Our results suggest that the introduction of a WISA is unlikely to be successful.