The effect of precommitment and past-experience on insurance choices : an experimental study
AbstractThis paper reports results from an experimental study that investigates insurance behaviours in low-probability high-loss risk situations. This study reveals that insurance behaviours may depend on the individual prior experience towards risk. It may also depend on the duration of the commitment period, namely the period during which individuals commit themselves to maintain the same insurance decision. Non-additive decision models such as Dual Theory and Cumulative Prospect Theory seem to have a higher descriptive power than Expected Utility Theory when explaining subjects' behaviours. This paper presents a direct experimental test of the prediction of Myopic Prospect Theory relative to insurance demand. This study is also designed to test the significance of gambler's fallacy and availability bias in the insurance decision process. These theoretical concepts help to understand many behaviours commonly observed in reality but which remain unexplained within the E.U framework. In particular, this paper provides new explanations about the puzzling fact that people usually fail to obtain insurance against disaster-type risks such as natural disasters, even when premiums are close to actuarially fair levels. According to our experimental results, the deficiency of insurance demand for natural disasters may be due to the lack of individual prior experience towards such risks ; as well as the relatively short commitment period of insurance policies (usually one fiscal year) compared with the empirical frequency of major natural hazards (centennial and even more).
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Bibliographic InfoPaper provided by Université Panthéon-Sorbonne (Paris 1) in its series Cahiers de la Maison des Sciences Economiques with number b04083.
Length: 31 pages
Date of creation: Sep 2004
Date of revision:
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Insurance demand; Low-probability high-consequence risks; heuristics and bias in risk perception; experimental methodology; Cumulative Prospect Theory; Dual Theory.;
Find related papers by JEL classification:
- C90 - Mathematical and Quantitative Methods - - Design of Experiments - - - General
- C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
- D1 - Microeconomics - - Household Behavior
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
- G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies
- M31 - Business Administration and Business Economics; Marketing; Accounting - - Marketing and Advertising - - - Marketing
This paper has been announced in the following NEP Reports:
- NEP-ALL-2005-12-09 (All new papers)
- NEP-CBE-2005-12-09 (Cognitive & Behavioural Economics)
- NEP-EXP-2005-12-09 (Experimental Economics)
- NEP-FIN-2005-12-09 (Finance)
- NEP-IAS-2005-12-09 (Insurance Economics)
- NEP-UPT-2005-12-09 (Utility Models & Prospect Theory)
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