Working Paper
Can Financial Markets be Tapped to Help Poor People Cope with Weather Risks?

Poor households with little or no wealth are particularly vulnerable to risks that reduce incomes and increase expenditures. This book addresses many of the risk-coping strategies for the rural poor, with a focus on micro level and household actions. Largely, these discussions concern risks that can be shared within a community or extended family. While effective for independent risks, these strategies are rather ineffective for covariate or systemic risks. This paper focuses on private and public mechanisms for managing such covariate risk for natural disasters. When many households within the same community face risks that create contemporaneous losses for all, the coping mechanisms discussed in other papers in this project are likely to fail. Such covariate risks are not uncommon in many developing countries, especially where farming remains a major source of income. The paper focuses on risks that are related to weather events (excess rain, droughts, freezes, high winds, etc.) that have a severe impact on rural incomes. Weather insurance could cover the covariate risk for a community of poor households through formal and informal risk-sharing arrangement among households that are purchasing these weather contracts. Given some recent Mexican innovations that are targeted at helping the poor cope with catastrophic weather events, we use Mexico as a case study to support some of our general concepts.