Equity Risk, Conversion Risk, and the Demand for Insurance
AbstractExisting insurance theory fails when applied to real property because it does not account for variations in the economic environment. The article studies optimal property insurance in the presence of two sources of variation: equity risk and conversion risk. Equity risk is randomness of the value of a property. It tends to raise demand for conventional insurance. In contrast, conversion risk is randomness in the value the property would have if, after severe damage, it were converted to the highest-valued use. It is distinct from equity risk because the highest-valued use is typically not the current one. Under independent conversion risk, the optimum upper limit is a compromise among underlying conversion thresholds. Absent independence, the optimum can be quite different. Conversion risk can raise or lower the demand for property insurance. Insurance contracts that fail to address conversion tend to undermine the orderly disposition of obligations and reduce the gains from reallocation of risks through insurance. Copyright The Journal of Risk and Insurance.
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Bibliographic InfoPaper provided by Department of Economics, UC Santa Barbara in its series University of California at Santa Barbara, Economics Working Paper Series with number qt87n8b5c5.
Date of creation: 17 Feb 1999
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Equity Risk; Conversion Risk; and the Demand for Insurance;
Other versions of this item:
- Rod Garratt & John M. Marshall, 2003. "Equity Risk, Conversion Risk, and the Demand for Insurance," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 70(3), pages 439-460.
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