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Liquidity Constraints and the Value of Insurance

Author

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  • Keith Marzilli Ericson
  • Justin Sydnor

Abstract

Insurance moves resources across both time and states. We study the consumption-smoothing benefits of insurance under liquidity constraints in a model where contracts span multiple consumption periods. The normative benchmarks for insurance demand under liquidity constraints differ qualitatively and quantitatively from the standard model: Individuals may only partially insure at actuarially fair prices, may benefit from insurance when premiums are very high and even sometimes when dominated, and may value insurance against events that will surely happen. Using simulations for health insurance, we highlight how these findings generate insights about how cost-sharing should be designed differently for liquidity-constrained populations.

Suggested Citation

  • Keith Marzilli Ericson & Justin Sydnor, 2026. "Liquidity Constraints and the Value of Insurance," American Economic Journal: Microeconomics, American Economic Association, vol. 18(3), pages 426-453, August.
    • Handle: RePEc:aea:aejmic:v:18:y:2026:i:3:p:426-53
    DOI: 10.1257/mic.20240042
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    More about this item

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth
    • G52 - Financial Economics - - Household Finance - - - Insurance

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