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Insuring a risky investment project

Author

Listed:
  • Henri Loubergé

    (University of Geneva and Swiss Finance Institute)

  • Richard Watt

    (University of Canterbury)

Abstract

In the standard model for insurance demand, the risk is totally exogenous and the insurance premium is paid for out of riskless wealth. This model yields results that are mostly in contradiction to everyday observation and have been used to question the pertinence of expected utility theory on which the model is based. For some years now, several papers have made attempts to provide foundations for a theory of insurance demand leading to less provocative comparative statics results. In these papers, the risk for which coverage is sought becomes endogenous and the decision to purchase insurance is made simultaneously with the decision how much to invest in insurable assets. All these papers use a standard financial investment framework. This paper offers a contribution to this literature by using a slightly different framework: the case of a firm exposed to an insurable risk affecting return on a real investment project. The model is kept simple by using a two-state environment. It yields results that are both more complete and more general than results in previous work with the same motivation.

Suggested Citation

  • Henri Loubergé & Richard Watt, 2006. "Insuring a risky investment project," Swiss Finance Institute Research Paper Series 06-25, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp0625
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    Cited by:

    1. is not listed on IDEAS
    2. Zhou, Chunyang & Wu, Wenfeng & Wu, Chongfeng, 2010. "Optimal insurance in the presence of insurer's loss limit," Insurance: Mathematics and Economics, Elsevier, vol. 46(2), pages 300-307, April.

    More about this item

    Keywords

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    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies

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