A Definition of ‘More Systemic Production Risk’ with Some Welfare Implications

Producers are subject to similar production risks, and so their outputs are likely positively correlated. This is believed to be among the main impediments to the creation of viable production risk insurance markets, is a major motive for such stabilization schemes as the holding of buffer stocks, and is a prominent motive for private storage activities. Taking a state contingent perspective, this paper provides a definition of systemic risk. We then show that an increase in this risk is both necessary and sufficient to ensure that any risk averse insurer is worse off. For risk-neutral producers, and for a variety of market structures, we trace the effects of an increase in systemic risk through to impacts on production and on welfare measures. Overall, expected welfare generally falls under more systemic risk but either of expected producer surplus or expected consumer surplus may rise. We also show that our definition of systemic risk has relevance in other areas of economics, such as the incentive to incur R&D expenditures. JEL classification: D8, G1, Q1