Consumption‐Based Asset Pricing in Insurance Markets: Yet Another Puzzle?

Alexander Braun, Daliana Luca and Hato Schmeiser

Journal of Risk & Insurance, 2019, vol. 86, issue 3, 629-661

Abstract: Although insurance is the typical textbook example for an asset that negatively correlates with consumption, the suitability of the classical consumption‐based asset pricing model with power utility to explain historical premiums and claims has not yet been tested. We fill this gap by fitting it to property–casualty market data for Australia, Italy, the Netherlands, the United States, and Germany. In doing so, we reveal yet another asset pricing anomaly. More specifically, the consumption‐based model implies even larger relative risk aversion coefficients in the insurance sectors than in the equity markets of the aforementioned countries. To solve this puzzle, we draw on the loss aversion and narrow framing approach by Barberis, Huang, and Santos (2001) as well as the second‐degree expectation dependence framework by Dionne, Li, and Okou (2015), with encouraging results.

Date: 2019
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