The Overconfidence Problem in Insurance Markets

ELSE Working Paper No. 2005 - 2

32 Pages Posted: 24 Jan 2005

Date Written: December 2004

Abstract

Adverse selection has long been recognized as a rationale for government intervention in insurance markets and for the adoption of public compulsory insurance. A different rationale for compulsory insurance is that overconfident individuals may underinsure because they underestimate the relevant risks. We show that government intervention is not a Pareto improvement in an adverse selection model with a significant fraction of overconfident agents. We underline that behavioral biases need not be the basis for government intervention. In fact, behavioral biases may overturn existing compelling reasons for intervention in the economy. Our model also delivers novel positive implications on aggregate variables that have been at the center of recent empirical investigation.

Keywords: Insurance, policy, behavioral economics

JEL Classification: D82, D4

Suggested Citation

Sandroni, Alvaro and Squintani, Francesco, The Overconfidence Problem in Insurance Markets (December 2004). ELSE Working Paper No. 2005 - 2, Available at SSRN: https://ssrn.com/abstract=653002 or http://dx.doi.org/10.2139/ssrn.653002

Alvaro Sandroni (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States
847-491-5461 (Phone)
847-467-1220 (Fax)

Francesco Squintani

University College London ( email )

Gower Street
London
United Kingdom

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