Essays on the microeconomics of flooding: economic impacts, behavioural factors and index-based insurance

Abstract

Floods are a global threat, affecting a quarter of the world's population, most of whom live in developing countries. They have severe impacts on welfare and poverty, although coping mechanisms can mitigate these effects. Accurately measuring flood impacts is crucial for assessing their economic consequences and understanding household responses and behaviours. Additionally, substantial losses in urban areas have increased interest in risk transfer products such as index-based insurance, which can offer financial protection, promote sustainable development, and enhance resilience to weather shocks. However, most empirical research on index insurance has focused on rural settings, where farmers are typically insured against income risks from rainfall variation or drought.

This dissertation addresses these gaps by proposing a novel method to estimate the economic impact of floods and by offering evidence on coping mechanisms in a middle-income country such as Peru. It also provides new evidence on factors -such as basis risk, time and risk preferences, price, and trust- that influence the adoption of index-based flood insurance in the urban contexts of Jakarta and Lima.

Chapter 2 analyses demand for hypothetical index-based flood insurance in Jakarta, using household data collected in 2018. Employing a probit specification with plausibly exogenous variables (basis risk, price, and extreme risk aversion), the study finds that demand decreases with basis risk, price, and risk aversion. A policy recommendation highlights the investment in more floodgate stations, particularly in western and southern regions, to reduce basis risk and increase insurance uptake. Chapter 3 examines the effects of the 2017 coastal El Nino floods on welfare and poverty in northern Peru. A novel damage index, constructed using remote sensing within the SWAT model, is combined with five years of panel data in a Difference-in-Differences Event Study. Results show that floods reduced income and expenditure per capita while increasing poverty, especially in urban areas. Households smoothed consumption mainly through disaster relief. The development of disaster insurance that bridges the gap between aid and actual losses -estimated at PEN 818.51 (USD 251.02)- could significantly enhance flood resilience among affected households. Chapter 4 explores the role of economic preferences, price, and trust in shaping demand for index-based insurance in Lima. Using household data from a lab-in-field experiment, I leverage the exogeneity of time and risk preferences, and price. The study shows that demand rises with time preference (measured by choices of larger, delayed payoffs) but falls with extreme risk aversion and price. Notably, trust in government flood mitigation plans increases willingness to purchase insurance among highly risk-averse households. Show more