Kiel Working Papers, Kiel Institute for World Economics
No 1750:
Insurance Demand and Prospect Theory
Ulrich Schmidt
Abstract: Empirical evidence has shown that people are unwilling to
insure rare losses at subsidized premiums and at the same time take-up
insurance for moderate risks at highly loaded premiums. This paper explores
whether prospect theory, in particular diminishing sensitivity and loss
aversion, can accommodate this evidence. A crucial factor for applying
prospect theory to insurance problems is the choice of the reference point.
We motivate and explore two possible reference points, state-dependent
initial wealth and final wealth after buying full insurance. It turns out
that particularly the latter reference point seems to provide a realistic
explanation of the empirical evidence
Keywords: insurance demand, prospect theory, flood insurance, diminishing sensitivity, loss aversion; (follow links to similar papers)
JEL-Codes: D14,; D81,; G21; (follow links to similar papers)
6 pages, January 2012
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