Consumption Externality and Equilibrium Underinsurance

16 Pages Posted: 7 Nov 2008

See all articles by Rachel J. Huang

Rachel J. Huang

National Central University at Taiwan - Department of Finance; Graduate Institute of Finance, NTUST

Larry Y. Tzeng

National Taiwan University - Department of Finance

Abstract

Relative consumption has been found to be crucial in many areas, such as asset pricing, the design of taxation, and economic growth. This article extends this line of research to the individual's insurance decision. We first define keeping up with the Joneses in the purchase of insurance and find that jealousy does not necessarily give rise to keeping up with the Joneses. We also identify several sufficient conditions that cause the optimal coverage in the private market to be less than the social optimum (equilibrium underinsurance). Jealousy is found to be neither a sufficient nor a necessary condition for equilibrium underinsurance. We further show that a social welfare maximizing government could adopt a tax system to correct for the consumption externality and make individuals better off.

Suggested Citation

Huang, Rachel J. and Tzeng, Larry, Consumption Externality and Equilibrium Underinsurance. Journal of Risk & Insurance, Vol. 75, Issue 4, pp. 1039-1054, December 2008. Available at SSRN: https://ssrn.com/abstract=1296896 or http://dx.doi.org/10.1111/j.1539-6975.2008.00296.x

Rachel J. Huang (Contact Author)

National Central University at Taiwan - Department of Finance ( email )

No. 300, Jhongda Rd, Jhogli City, Taoyuan, Taiwan,
Jhongli, TY 32001
Taiwan

Graduate Institute of Finance, NTUST ( email )

#43,Sec.4
Keelung Rd
Taipei, Taipei 106
Taiwan

Larry Tzeng

National Taiwan University - Department of Finance ( email )

1 Sec. 4, Roosevelt Road
Taipei, 106
Taiwan

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