Basis risk or residual risk arising from disparity between an index’s estimate of losses and actual losses is inherent in index-based insurance products. We approximate basis risk as the false negative probability (FNP) within pasture, rangeland, and forage (PRF) rainfall index insurance for the south-central coastal region of California. We estimate the FNP on average that at least one of two selected coverage intervals will fail to provide an indemnity when a loss is realized at 48%. The average FNP is reduced to only 11% when considering whether both selected intervals fail to provide an indemnity when a loss is realized.
Feuz, Ryan; Bosworth, Ryan; Larsen, Ryan; Larsen, Royce; Klein, Sean; Shapero, Matthew W.K.; Rao, Devii R.; Althouse, LynneDee; and Striby, Karl
"Expanding on Basis Risk Estimates for Pasture, Rangeland, and Forage Insurance,"
Journal of Applied Farm Economics: Vol. 6
Available at: https://docs.lib.purdue.edu/jafe/vol6/iss1/1