Impact of Index Insurance on Moral Hazard in the Agricultural Credit Market: Theory and Evidence from Ghana

Recent research suggests that coupling microfinance loans with an index insurance policy may be a cost-effective way to expand credit market access to smallholder farmers in developing countries. Index insurance can increase demand for credit and encourage increased supply of credit by protecting borrowers and lenders from covariate production shocks that discourage credit market expansion. In this paper, we propose that index insurance, when bundled with credit, may also reduce a different barrier to credit market access: high transaction costs caused by moral hazard in the credit market. We develop a theoretical model of a competitive credit market with moral hazard. In this market, lenders use either dynamic incentives or collateral to mitigate the moral hazard problem. The model shows that index insurance bundled with loan contracts can reduce moral hazard and increase borrower welfare. We then test the model and find some empirical support using a subset of data from a randomised control trial in northern Ghana.

Estimating Demand for Third-party Quality Testing in Rural Grain Markets: Evidence from an Experimental Auction for Measuring Moisture Content in Kenya

Traders in informal grain markets often lack incentives to sell grain dried to a moisture level that is safe for storage, due to weak regulations and lack of low-cost moisture testing technologies. This study estimated the demand for a third-party moisture testing service in western Kenya that can encourage safe drying and reduce asymmetric information between buyers and sellers. We utilised a Becker–DeGroot–Marschak (BDM) auction to obtain maize traders’ willingness to pay (WTP) for the moisture testing service and compared it with two alternative multiple price list (MPL) mechanisms for eliciting WTP. Traders had the opportunity to bid on the testing service with two different moisture metres. The first was a low-cost hygrometer that measures temperature and relative humidity and costs about $2.50. The second was a commercial moisture metre that costs $170 in USA but provides a more precise reading. Results suggest that the standard BDM auction and both MPL variants produced similar estimates of demand for our moisture testing service. On average, traders were willing to pay $0.28 to have their maize tested with the hygrometer and $0.39 with the moisture metre. An additional take-it-or-leave-it auction for the hygrometer itself revealed that traders were not sensitive to price changes around market price, although only 15% of the traders purchased the device. A service provider model using either device could be a way to make moisture testing accessible in rural grain markets in the absence of a supply chain that sells these devices directly.