Solving Life Cycle Problems With Biometric Risk by Artificial Insurance Markets
28 Pages Posted: 14 Dec 2018 Last revised: 20 Apr 2021
Date Written: April 20, 2021
We study canonical consumption-savings problems of an individual involving uninsurable biometric risk. These problems are important in many applications from insurance economics and actuarial science. Since biometric risk is uninsurable, closed-form solutions do not exist and thus the problems must be approached by numerical methods. We propose a powerful approach where the solution is obtained by optimizing over a parametrized family of consumption strategies. In settings with mortality risk, critical illness risk, and habit formation, our solution method outperforms the well-established finite-difference approach both in run time and in precision. Our method also delivers a precision measure and closed-form representations of the optimal controls.
Keywords: dynamic programming, life-cycle models, biometric risk, insurance, habit formation
JEL Classification: G10, D14, D91, E21, R21
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