Insurance Demand and Prospect Theory
AbstractEmpirical evidence has shown that people are unwilling to insure rare losses at subsidized premiums and at the same time take-up insurance for moderate risks at highly loaded premiums. This paper explores whether prospect theory, in particular diminishing sensitivity and loss aversion, can accommodate this evidence. A crucial factor for applying prospect theory to insurance problems is the choice of the reference point. We motivate and explore two possible reference points, state-dependent initial wealth and final wealth after buying full insurance. It turns out that particularly the latter reference point seems to provide a realistic explanation of the empirical evidence
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Bibliographic InfoPaper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1750.
Length: 6 pages
Date of creation: Jan 2012
Date of revision:
insurance demand; prospect theory; flood insurance; diminishing sensitivity; loss aversion;
Find related papers by JEL classification:
- D14 - Microeconomics - - Household Behavior - - - Personal Finance
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-01-18 (All new papers)
- NEP-CBE-2012-01-18 (Cognitive & Behavioural Economics)
- NEP-IAS-2012-01-18 (Insurance Economics)
- NEP-UPT-2012-01-18 (Utility Models & Prospect Theory)
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