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Is insurance normal or inferior? -A regret theoretical approach-

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  • Fujii, Yoichiro
  • Okura, Mahito
  • Osaki, Yusuke

Abstract

This study considers how changes in wealth affect insurance demand when individuals suffer disutility from regret. Anticipated regret stems from a comparison between the ex-post maximum and actual wealth. We consider a situation wherein individuals maximize their expected utility incorporating anticipated regret. The wealth effect on insurance demand can be classified into the risk and the regret effects. These effects are determined by the properties of the utility function and the regret function. We show that insurance can be normal when individuals place weight on anticipated regret, even though the utility function exhibit decreasing absolute risk aversion. This result indicates that regret theory is a possible explanation to the wealth effect puzzle, in which insurance is normal from empirical observation, but it should be inferior by theoretical prediction under expected utility theory.

Suggested Citation

  • Fujii, Yoichiro & Okura, Mahito & Osaki, Yusuke, 2021. "Is insurance normal or inferior? -A regret theoretical approach-," The North American Journal of Economics and Finance, Elsevier, vol. 58(C).
    • Handle: RePEc:eee:ecofin:v:58:y:2021:i:c:s1062940821001674
    DOI: 10.1016/j.najef.2021.101559
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    References listed on IDEAS

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    1. Armantier, Olivier & Foncel, Jérôme & Treich, Nicolas, 2023. "Insurance and portfolio decisions: Two sides of the same coin?," Journal of Financial Economics, Elsevier, vol. 148(3), pages 201-219.

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    More about this item

    Keywords

    Decreasing absolute risk aversion; Demand shift; Regret sensitivity; Wealth effect puzzle;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G52 - Financial Economics - - Household Finance - - - Insurance

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