Insurance demand and prospect theory

Ulrich Schmidt

No 1750, Kiel Working Papers from Kiel Institute for the World Economy (IfW Kiel)

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 (search for similar items in EconPapers)
JEL-codes: D14 D81 G21 (search for similar items in EconPapers)
Date: 2012
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:ifwkwp:1750

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