On the optimality of straight deductibles under smooth ambiguity aversion

Yichun Chi, Richard Peter and Wei Wei

Journal of Economic Behavior & Organization, 2025, vol. 234, issue C

Abstract: We solve the optimal insurance design problem under identifiable smooth ambiguity aversion with linear transaction cost. We impose monotonicity on indemnity schedules and their associated retention functions. Arrow’s cornerstone result that a straight deductible is optimal may fail to hold. We provide three conditions to restore it: (i) ambiguity does not affect large losses; (ii) priors are ordered according to first-order stochastic dominance and the probability of worse priors is greater conditional on observing a large loss than a small loss; or (iii) priors are ordered in the hazard rate order. We also derive comparative statics and find intuitive results.

Keywords: Insurance design; Smooth ambiguity aversion; Straight deductible; No-sabotage condition; Comparative statics (search for similar items in EconPapers)
JEL-codes: D81 D86 G22 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:234:y:2025:i:c:s0167268125001210

DOI: 10.1016/j.jebo.2025.107001

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