Second-best insurance contract design in an incomplete market
This paper considers the optimal form of insurance contracts for multiple risks. A well-known result in the literature is that, under fairly general conditions, an insurance policy with a deductible for aggregate losses is optimal. We provide a new proof of this result based only on stochastic dominance (whereas existing proofs require dynamic optimization techniques). Considering a real-world incompleteness, whereby separate loss exposures are indemnified via separate contracts, we show that separate deductibles are second-best optima in this setting. We compare the indemnity provided in this second-best setting with first-best solutions. The effect of second-best contracts on the individual's total insurance demand is also examined.
|Date of creation:||01 Feb 1992|
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