Chapter 2: Risk and Poverty
LIFE AND RISK Life is subject to all kinds of ﬂuctuations. Some of these ﬂuctuations are predictable: the absence of rain in the dry season, the utter helplessness of the newborn, the declining strength of the old. Others occur in a haphazard fashion that cannot be predicted, at least not precisely. These ﬂuctuations constitute the rhythm of life. They must be dealt with, in one way or another, otherwise life can become highly unpleasant. Taking care of these ﬂuctuations constitutes risk coping strategies. The main concern is with the strategies people use to minimize the impact of these ﬂuctuations on their welfare. Thus, the deﬁnition of risk factors encompasses both predictable and unpredictable variations in income and health. In a recent review of informal insurance mechanisms, Morduch (1999) proposes three conceptual distinctions that are useful to characterize risk factors in general: high and low frequency risks; autocorrelated and non-autocorrelated risks; and covariate and idiosyncratic risks (see also Morduch (1995) and Fafchamps (2003a)). High and low frequency risk: Risk is, by deﬁnition, a process that unfolds over time. Certain risk factors such as minor illnesses occur frequently; others such as locust attacks are fortunately quite rare. As a ﬁrst approximation, individual risk factors can be thought of as being realizations of a Poisson process in which the number of occurrences Zj(t) of a particular shock j over a time interval t follow: Pr[Zj(t)ϭz]ϭ ejtztz j z! (2.1) where parameter j denotes the mean...
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