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Equity Risk, Conversion Risk, and the Demand for Insurance

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Listed:
  • Garratt, Rod
  • Marshall, John M.

Abstract

Existing insurance theory fails when applied to real property because it does not account for variations in the economic environment. The article studies optimal property insurance in the presence of two sources of variation: equity risk and conversion risk. Equity risk is randomness of the value of a property. It tends to raise demand for conventional insurance. In contrast, conversion risk is randomness in the value the property would have if, after severe damage, it were converted to the highest-valued use. It is distinct from equity risk because the highest-valued use is typically not the current one. Under independent conversion risk, the optimum upper limit is a compromise among underlying conversion thresholds. Absent independence, the optimum can be quite different. Conversion risk can raise or lower the demand for property insurance. Insurance contracts that fail to address conversion tend to undermine the orderly disposition of obligations and reduce the gains from reallocation of risks through insurance. Copyright The Journal of Risk and Insurance.
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • Garratt, Rod & Marshall, John M., 1999. "Equity Risk, Conversion Risk, and the Demand for Insurance," University of California at Santa Barbara, Economics Working Paper Series qt87n8b5c5, Department of Economics, UC Santa Barbara.
  • Handle: RePEc:cdl:ucsbec:qt87n8b5c5
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    References listed on IDEAS

    as
    1. Kimball, Miles S, 1990. "Precautionary Saving in the Small and in the Large," Econometrica, Econometric Society, vol. 58(1), pages 53-73, January.
    2. Mayers, David & Smith, Clifford W, Jr, 1983. "The Interdependence of Individual Portfolio Decisions and the Demand for Insurance," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 304-311, April.
    3. Doherty, Neil A & Schlesinger, Harris, 1983. "Optimal Insurance in Incomplete Markets," Journal of Political Economy, University of Chicago Press, vol. 91(6), pages 1045-1054, December.
    4. J.M. Bourgeon & P. Picard, 1999. "Reinstatement or insurance payment in corporate fire insurance," THEMA Working Papers 99-46, THEMA (THéorie Economique, Modélisation et Applications), Université de Cergy-Pontoise.
    5. Shiller, Robert J & Weiss, Allan N, 1999. "Home Equity Insurance," The Journal of Real Estate Finance and Economics, Springer, vol. 19(1), pages 21-47, July.
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