Risk Management and Insurance Decisions under Ambiguity

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I study the impact of ambiguity on insurance decisions and the optimality of insurance contracts. My tractable approach allows me to study the interaction between risk and ambiguity attitudes. When insurance decisions are made independently of other assets, for a given increase in wealth, both risk and ambiguity attitudes interact in nontrivial ways to determine the change of coinsurance demand. I derive sufficient conditions to guarantee that the optimal coinsurance demand is decreasing in wealth. When a non-traded asset is introduced, my model predicts behavior that is inconsistent with the classical portfolio theory that assumes Subjective Expected Utility theory; however, it provides hints to a possible solution of the under-diversification puzzle of households. I also identify conditions under which more risk or ambiguity aversion decreases the demand for coinsurance. Additionally, I show a counterexample to a classical result in insurance economics where an insurance contract with straight deductible is dominated by a coinsurance contract. Finally, I find that a modified Borch rule characterizes the optimal insurance contract with bilateral risk and ambiguity
attitudes and heterogeneity in beliefs.
Original languageEnglish
Publication date2012
Number of pages54
Publication statusPublished - 2012
EventCEAR/MRIC Behavioral Insurance Workshop 2012 - Carl Friedrich von Siemens Stiftung, München, Germany
Duration: 10 Dec 201211 Dec 2012


WorkshopCEAR/MRIC Behavioral Insurance Workshop 2012
LocationCarl Friedrich von Siemens Stiftung
Internet address

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