This website uses cookies.

By clicking the "Accept" button or continuing to browse our site, you agree to first-party and session-only cookies being stored on your device to enhance site navigation and analyze site performance and traffic. For more information on our use of cookies, please see our Privacy Policy.

  1. Home
  2. Journals
  3. American Economic Journal: Microeconomics
  4. February 2016
  5. A Theory of Rational Demand for Index Insurance

American Economic Journal:
Microeconomics

ISSN 1945-7669 (Print) | ISSN 1945-7685 (Online)

A Theory of Rational Demand for Index Insurance

  • Daniel J. Clarke
American Economic Journal: Microeconomics
vol. 8, no. 1, February 2016
(pp. 283–306)
Download Full Text PDF

Abstract

Rational demand for index insurance products is shown to be fundamentally different to that for indemnity insurance products due to the presence of basis risk. In particular, optimal demand is zero for infinitely risk-averse individuals, and is nonmonotonic in risk aversion, wealth, and price. For a given belief, upper bounds are derived for the optimal demand from risk-averse and decreasing absolute risk-averse decision makers. A simple ratio for monitoring basis risk is presented and applied to explain the low level of demand for consumer hedging instruments as a rational response to deadweight costs and basis risk. (JEL D14, D81, G13, G22, Q14)

Citation

Clarke, Daniel J. 2016. "A Theory of Rational Demand for Index Insurance." American Economic Journal: Microeconomics, 8 (1): 283–306. DOI: 10.1257/mic.20140103

Additional Materials

JEL Classification

  • D14 Household Saving; Personal Finance
  • D81 Criteria for Decision-Making under Risk and Uncertainty
  • G13 Contingent Pricing; Futures Pricing; option pricing
  • G22 Insurance; Insurance Companies; Actuarial Studies
  • Q14 Agricultural Finance
There are no comments for this article.
Login to Comment