Loss Aversion Leading to Advantageous Selection

41 Pages Posted: 6 Nov 2014

See all articles by Christina Aperjis

Christina Aperjis

Hewlett-Packard Enterprise - Social Computing Lab

Filippo Balestrieri

Hewlett-Packard Laboratories

Date Written: October 31, 2014

Abstract

Some insurance markets are characterized by “advantageous selection,” that is, ex-post risk and coverage are negatively correlated. We show that expectation-based loss aversion as in K'oszegi and Rabin (2006, 2007) provides a natural explanation for this phenomenon when agents face modest scale risks. More exposure to risk has two competing effects on an agent's willingness to pay for insurance: a positive effect, as in standard expected utility models; and a negative one, due to a reference effect. We determine conditions under which an insurance provider optimally sets a high price at which only low risk agents buy.

Keywords: loss aversion, advantageous selection, insurance

JEL Classification: D81, D82, D11, D42

Suggested Citation

Aperjis, Christina and Balestrieri, Filippo, Loss Aversion Leading to Advantageous Selection (October 31, 2014). Available at SSRN: https://ssrn.com/abstract=2517643 or http://dx.doi.org/10.2139/ssrn.2517643

Christina Aperjis

Hewlett-Packard Enterprise - Social Computing Lab ( email )

1501 Page Mill Road
Palo Alto, CA 9434
United States

Filippo Balestrieri (Contact Author)

Hewlett-Packard Laboratories ( email )

1501 Page Mill Road
Palo Alto, CA 94304
United States

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