Optimal Demand for Insurance with Consumption Commitments

Asia-Pacific Journal of Risk and Insurance, Forthcoming

30 Pages Posted: 18 Feb 2012 Last revised: 1 Apr 2014

See all articles by Hua Chen

Hua Chen

University of Hawaiʻi at Mānoa

Reza S. Mahani

Georgia Tech Finance/Scheller

Date Written: November 23, 2011

Abstract

Some consumption goods, such as housing, involve long-term commitment and their level of consumption can only be altered with substantial transaction costs. Even though the commitment effect on risk preferences, portfolio choice, and asset prices has been studied, little research has been conducted on its effect on insurance demand. In this paper, we propose a two-stage model to investigate the optimal demand for insurance by agents who derive utility from the consumption of two goods, an easily adjustable good (food) and a commitment good (housing). Our numerical analysis supports the prediction by Chetty and Szeidl (2007) that commitments help rationalize the high demand for insurance against moderate losses. Moreover, our model can explain the low insurance demand for catastrophic risks to some extent. We extend our model to include both insurance purchase and investment in a risky asset. Our results indicate that, with commitments, insurance appears to be a normal good within certain wealth regions. We also find that only when the initial wealth and housing are rather inconsistent individuals are likely to purchase insurance and lottery tickets simultaneously.

Keywords: Insurance Demand, Consumption Commitment, Risk Preferences

JEL Classification: G22

Suggested Citation

Chen, Hua and Mahani, Reza S., Optimal Demand for Insurance with Consumption Commitments (November 23, 2011). Asia-Pacific Journal of Risk and Insurance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2007343

Hua Chen (Contact Author)

University of Hawaiʻi at Mānoa ( email )

2404 Maile Way, E-602e
Honolulu, HI 96822
United States
(808) 956-8063 (Phone)
(808) 956-9887 (Fax)

Reza S. Mahani

Georgia Tech Finance/Scheller ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

HOME PAGE: http://scheller.gatech.edu

Register to save articles to
your library

Register

Paper statistics

Downloads
67
rank
331,203
Abstract Views
561
PlumX Metrics
!

Under construction: SSRN citations while be offline until July when we will launch a brand new and improved citations service, check here for more details.

For more information