Aase, Knut K. () (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)
Abstract
A standard result states that under decreasing absolute risk aversion the indifference premium of the insured is a decreasing function of wealth. This has been interpreted to mean that insurance is an inferior good, which has been considered as a puzzle in insurance theory, in particular since the result does not seem to explain observed behavior in insurance markets.
We reformulate the standard model of risk sharing to incorporate the amount invested in the insurable asset. From this we identify two wealth effects, one direct and one indirect. The direct one is explained by the classical result, and is negative when risk aversion is decreasing. The indirect effect is positive when the insurable asset is a normal good, and we find conditions when insurance is a normal good, and when it is not.
The analysis is extended to Pareto optimal risk sharing, where we also analyze the joint problem of finding an optimal amount in the insurable asset, as well as a Pareto optimal insurance contract. In this latter case insurance turns out to be inelastic to changes in wealth of the insurance customer, provided the insurer’s reserves are held fixed, but a normal good if this assumption is relaxed.
Download Info
To download:
If you experience problems downloading a file, check if you have the
proper application to
view it first. Information about this may be contained
in the File-Format links below. In case of further problems read
the IDEAS help
page. Note that these files are not on the IDEAS
site. Please be patient as the files may be large.
Publisher Info
Paper provided by Department of Finance and Management Science, Norwegian School of Economics and Business Administration in its series Discussion Papers with number
2007/6.
Length: 33 pages Date of creation: 13 Feb 2007 Date of revision: Handle: RePEc:hhs:nhhfms:2007_006
Contact details of provider: Postal: NHH, Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway Phone: +47 55 95 92 93 Fax: +47 55 95 96 50 Email: Web page: http://www.nhh.no/for/ More information through EDIRC
For technical questions regarding this item, or to correct its listing, contact: (Stein Fossen).
References listed on IDEAS Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
Cited by: (explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)