Precautionary Saving and Insurance Under Generalized Mean-Variance Preferences
31 Pages Posted: 30 Mar 2017
Date Written: March 29, 2017
We analyze the optimal insurance demand in a dynamic setup with two periods. In addition to the possibility to insure, the investor is allowed to transfer wealth between the two periods, i.e. she can save. While it is difficult to interpret the optimal saving and insurance decisions without disentangling time and risk preferences, we do so in a generalized mean variance setup. In this dynamic setup we state a natural way to separate between time and risk preferences by means of a variance decomposition. We show that we are in- deed able to disentangle the preferences. While the variance within the period where a loss can occur determines the optimal insurance level, the aversion against the variance between the expected wealth at different times gives the optimal savings decision. The results are tractable and easy to interpret.
Keywords: Precautionary saving, insurance, mean variance preferences
JEL Classification: D81, D91, E21
Suggested Citation: Suggested Citation