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Almost universally, crop insurance uptake has been very low in the absence of significant governmental subsidies. We proposed an explanation for the low uptake by analyzing farmers’ optimal behavior in the presence of subsidized crop insurance and incomplete financial markets. Under specific replication conditions, farmers’ valuation of crop insurance is lower than insurers’ valuation if farmers have access to fewer financial assets than insurers. A potential rationalization is that farmers and insurers have dissimilar price formation processes. Our model implies that subsidized crop insurance changes farmers’ production choices by altering both the relative returns across states of Nature and their risk choices. However, because of the separation between consumption and production decisions, farmers will use crop insurance in a manner consistent with profit maximization, independent of risk preferences.

Subsidized Crop Insurance under Limited Access to Incomplete Financial Markets