Consumption insurance against natural disasters: evidence from the Great Hanshin-Awaji (Kobe) earthquake

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  • This article was downloaded by: [University of Connecticut]On: 10 October 2014, At: 05:39Publisher: RoutledgeInforma Ltd Registered in England and Wales Registered Number: 1072954 Registered office: Mortimer House,37-41 Mortimer Street, London W1T 3JH, UK

    Applied Economics LettersPublication details, including instructions for authors and subscription information:http://www.tandfonline.com/loi/rael20

    Consumption insurance against natural disasters:evidence from the Great Hanshin-Awaji (Kobe)earthquakeYasuyuki Sawada a & Satoshi Shimizutani ba Faculty of Economics , University of Tokyo , 7-3-1 Hongo, Bunkyo-ku, Tokyo 113-0033,Japanb Institute of Economic Research , Hitotsubashi University , 2-1 Naka, Kunitachi-shi, Tokyo186-8603, JapanPublished online: 18 Feb 2011.

    To cite this article: Yasuyuki Sawada & Satoshi Shimizutani (2007) Consumption insurance against natural disasters:evidence from the Great Hanshin-Awaji (Kobe) earthquake, Applied Economics Letters, 14:4, 303-306, DOI:10.1080/13504850500447364

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  • Applied Economics Letters, 2007, 14, 303306

    Consumption insurance against

    natural disasters: evidence from the

    Great Hanshin-Awaji (Kobe)

    earthquake

    Yasuyuki Sawadaa and Satoshi Shimizutanib,*

    aFaculty of Economics, University of Tokyo, 7-3-1 Hongo, Bunkyo-ku,

    Tokyo 113-0033, JapanbInstitute of Economic Research, Hitotsubashi University, 2-1 Naka,

    Kunitachi-shi, Tokyo 186-8603, Japan

    We investigated whether people were insured against unexpected losses

    caused by the Great Hanshin-Awaji (Kobe) earthquake in 1995 and found

    that the full consumption insurance hypothesis was rejected overwhel-

    mingly, suggesting the ineffectiveness of the formal/informal insurance

    mechanisms against the earthquake.

    I. Introduction

    The Great Hanshin-Awaji (Kobe) earthquake, whichoccurred on 17 January 1995, induced one of thelargest economic damages recorded in history(Horwich, 2000; Sawada and Shimizutani, 2005). Asan unexpected exogenous event, an earthquakeprovides an unusual situation under which we cantest the full consumption insurance hypothesis byapplying the empirical strategy of Cochrane (1991)and Mace (1991) to our unique data on the earth-quake. Kohara et al. (2001,2002) rejected the fullconsumption insurance hypothesis against the earth-quake by employing region-specific slope dummiesfor the income change variables. However, thesevariables are not exogenous to a household, resultingin a possible estimation bias (Cochrane, 1991; Mace,1991). Our findings are less susceptible to econo-metric problems since we tested consumption reactionto direct shocks caused by the unexpected event,which cannot be affected by households. To the bestof our knowledge, our data is one of the few data sets

    that allow us to test the hypothesis using directshocks caused by the earthquake. Section II estab-lishes the theoretical and econometric frameworks.Section III briefly describes the data and presents ourfindings.

    II. The Framework

    Under full risk sharing, we obtain the conditions bysolving a benevolent social planners problem tomaximize the weighted sum of peoples utilities(Cochrane, 1991; Mace, 1991):

    u 0citu 0cit1

    u0cjt

    u 0cjt11

    where u () is a concave instantaneous utility of ahousehold, c is the household consumption and i andj denote the i-th and j-th household, respectively.Suppose that the utility function takes the form

    *Corresponding author. E-mail: sshimizu@ier.hit-u.ac.jp

    Applied Economics Letters ISSN 13504851 print/ISSN 14664291 online 2007 Taylor & Francis 303http://www.tandf.co.uk/journalsDOI: 10.1080/13504850500447364

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  • of a constant absolute risk aversion function, i.e.

    u(cit)(1/) exp(cit), we obtain1:

    cit 1

    N

    XNj1

    cjt

    !2

    where is a first-difference operator and N

    represents the number of households in an insurance

    network. Under full insurance, the idiosyncratic

    household income changes should be absorbed by

    all other members in the same insurance network, andthese shocks should not affect the changes in

    consumption.Following Cochrane (1991) and Ravallion and

    Chaudhuri (1997), our empirical specification to test

    Equation 2 can be expressed as follows:

    ci XKk1

    kRak Si ui 3

    where k is an identifier of regional insurance net-

    works and Ra is a dummy variable, which is equal toone if the i-th household is located in the region k. We

    utilize the area dummies for the variable Ra to control

    the average change in consumption. The matrix, S,

    comprises indicators of income and nonincome

    shocks. The final is a well-behaved error term.The null hypothesis is that all the elements of a

    vector, , in Equation 3 are jointly zero. Although we

    cannot identify the direction of consumption changes

    from our data, we can observe whether consumption

    has changed and can also use this variable as a

    dependent variable. Even in such cases, the rejection

    of the null hypothesis should coincide with the

    rejection of the necessary condition for the full

    insurance model, while the failure to reject does not

    necessarily support the full insurance model.We can construct a dummy variable, I c, which

    takes the value of two for major changes, one for

    minor changes, and zero otherwise. Accordingly, we

    employ the ordered probit model to test Equation 3:

    I ci 2 if ci is large Choice 1

    1 if ci is small Choice 2

    0 otherwise Choice 3:

    III. Data and Empirical Results

    We employed the micro-level data from Shinsai-go no

    Kurashi no Henka kara Mita Shouhi Kouzou ni Tsuite

    no Chousa Houkokusho (research report on changes in

    lifestyles and consumption behaviour following the

    disaster), a survey conducted in the Hyogo Prefecture

    in October 1996 (Hyogo Prefecture, 1997). This survey

    was completed by 1589 women aged above 30, who

    Table 1. Basic statistics

    Variables Mean

    Consumption changes (before and after the earthquake)Dummy 1 for major changes in consumption behaviour 0.095Dummy 1 for minor changes in consumption behaviour 0.532

    Income shocks caused by the earthquakeDummy 1 for positive income shock 0.063Dummy 1 for negative income shock 0.339

    Nonincome shocks caused by the earthquakeDummy 1 for major damages to houses 0.129Dummy 1 for moderate damages to houses 0.175Dummy 1 for minor damages to houses 0.409Dummy 1 for major damages to household assets 0.079Dummy 1 for minor damages to household assets 0.707Dummy 1 for health-related shocks 0.177

    Regional variablesDummy 1 for Higashinada-ku (default category) 0.125Dummy 1 for Kita-ku 0.170Dummy 1 for Suma-ku 0.145Dummy 1 for Akashi city 0.334Dummy 1 for Nishinomiya city 0.210Dummy 1 for other areas 0.016

    1Our empirical framework will not change under the constant relative risk aversion (CRRA) utility.

    304 Y. Sawada and S. Shimizutani

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  • were selected on the basis of a stratified randomsampling scheme in the six seriously affected areas.

    Table 1 reports the summary statistics of thevariables. First, less than 10% of all respondentschanged their consumption substantially, and morethan half of them changed it slightly. Second, wehave two types of income shock variables adummy variable for a positive income shock causedby the earthquake (6.3% of all respondents) and adummy variable for a negative income shock(33.9%). Third, we obtain a set of nonincomeshock variables to record the details of the damages,including those to the house, the householdassets, and the health of the family members.2

    Of the respondents, 71.3% and 78.6% incurreddamages to their houses and household a

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