The effects of overconfident yield forecasting on cross-coverage level crop insurance demand

Abstract

Purpose

This paper examines the effect of overconfident yield forecasting (optimism bias) on crop insurance coverage level choices across both yield and revenue insurance.

Design/methodology/approach

This study simulates a representative producer’s preferred coverage level for both yield and revenue insurance under three potential models of decision-making and four potential manifestations of overconfident yield forecasting. The study then uses this framework to examine how coverage level choices change as overconfidence increases (decreases).

Findings

As overconfidence increases, producers prefer lower levels of crop insurance coverage than they would otherwise prefer, with extreme overconfidence inducing farmers to buy no insurance at all. While overconfidence affects cross-coverage demand for revenue and yield insurance similarly, this effect is more pronounced for yield insurance. Cross-coverage level demand for revenue insurance is relatively stable across changes in the correlation between prices and yields.

Practical implications

This research has important implications for crop insurance subsidy design and crop insurance demand modeling.

Originality/value

There is a growing body of literature suggesting that producers are overconfident with regard to their future yield risk and that this bias reduces their willingness to pay for risk management tools such as crop insurance. This is the first study to look at how such overconfidence affects cross-coverage level demand for crop insurance.

Citation

Michaud, C.P. (2022), "The effects of overconfident yield forecasting on cross-coverage level crop insurance demand", Agricultural Finance Review, Vol. 82 No. 4, pp. 657-674. https://doi.org/10.1108/AFR-05-2021-0065