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An optimal insurance design problem under Knightian uncertainty

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  • Carole Bernard

    ()

  • Shaolin Ji

    ()

  • Weidong Tian

    ()

Abstract

This paper solves an optimal insurance design problem in which both the insurer and the insured are subject to Knightian uncertainty about the loss distribution. The Knightian uncertainty is modeled in a multi-prior g-expectation framework. We obtain an endogenous characterization of the optimal indemnity that extends classical theorems of Arrow (Essays in the Theory of Risk Bearing. Markham, Chicago 1971 ) and Raviv (Am Econ Rev 69(1):84–96, 1979 ) in the classical situation. In the presence of Knightian uncertainty, it is shown that the optimal insurance contract is not only contingent on the realized loss but also on another source of uncertainty coming from the ambiguity. Copyright Springer-Verlag 2013

Suggested Citation

  • Carole Bernard & Shaolin Ji & Weidong Tian, 2013. "An optimal insurance design problem under Knightian uncertainty," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 36(2), pages 99-124, November.
  • Handle: RePEc:spr:decfin:v:36:y:2013:i:2:p:99-124
    DOI: 10.1007/s10203-012-0127-5
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Knightian uncertainty; Insurance; Contingency; C61; D81;

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty

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