Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/55277
Authors: 
Schmidt, Ulrich
Year of Publication: 
2012
Series/Report no.: 
Kiel Working Paper 1750
Abstract: 
Empirical evidence has shown that people are unwilling to insure rare losses at subsidized premiums and at the same time take-up insurance for moderate risks at highly loaded premiums. This paper explores whether prospect theory, in particular diminishing sensitivity and loss aversion, can accommodate this evidence. A crucial factor for applying prospect theory to insurance problems is the choice of the reference point. We motivate and explore two possible reference points, state-dependent initial wealth and final wealth after buying full insurance. It turns out that particularly the latter reference point seems to provide a realistic explanation of the empirical evidence.
Subjects: 
insurance demand
prospect theory
flood insurance
diminishing sensitivity
loss aversion
JEL: 
D14
D81
G21
Document Type: 
Working Paper

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