The effect of overconfidence on insurance demand

Sandroni and Squintani (Am Econ Rev 97(5):1994–2004, 2007) argue that in the presence of overconfident agents, the findings of Rothschild and Stiglitz (Q J Econ 90:629–649, 1976) no longer hold since compulsory insurance makes the low-risk agents worse off. The main assumption of Sandroni and Squintani (2007) is that there exists a causal link between overconfidence and insurance-purchasing behavior. In this paper, I use a design similar to Camerer and Lovallo (Am Econ Rev 89(1):306–318, 1999) to establish this causal link. I show that overconfident subjects purchase significantly less actuarially fair insurance when the probability of loss is unknown and it depends on their own unknown ability than when the probability of loss is known.