The investment decisions of small-scale farmers in developing countries are conditioned
by their financial environment. Binding credit market constraints and incomplete
insurance can reduce investment in activities with high expected profits. We conducted
several experiments in northern Ghana in which farmers were randomly assigned to
receive cash grants, grants of or opportunities to purchase rainfall index insurance, or a
combination of the two. Demand for index insurance is strong, and insurance leads to
significantly larger agricultural investment and riskier production choices in agriculture.
The salient constraint to farmer investment is uninsured risk: when provided with
insurance against the primary catastrophic risk they face, farmers are able to find
resources to increase expenditure on their farms. Demand for insurance in subsequent
years is strongly increasing in a farmer’s own receipt of insurance payouts, and with the
receipt of payouts by others in the farmer’s social network. Both investment patterns and
the demand for index insurance are consistent with the presence of important basis risk
associated with the index insurance, and with imperfect trust that promised payouts will
be delivered.