This paper investigates how development of credit and insurance markets affects welfare of poor farmers LDCs and the process of economic development. By using two different data sets from rural Pakistan, i. e., a small-scale village survey data set and a nation-wide household survey data, the paper statistically tests the necessary condition for efficient risk sharing. The hypothesis tests enable us to evaluate how poor farmers' consumption is insulated from their income shocks. The empirical results are twofold. First, we found that idiosyncratic income shocks are insured well and there exist extensive mutual insurance schemes in village economies. Second, the results, however, indicate that inter-village or nation-wide risk-sharing devices are less available. Their policy implication is that construction of wide-scale insurance schemes such as nation-wide crop insurance program, insurance against flood and draught, and employment guarantee schemes will generate substantial positive welfare effects by complementing small-scale informal insurance devices.
