Risk, ambiguity, and insurance

Abstract

In a series of experiments, economically sophisticated subjects, including professional actuaries, priced insurance both as consumers and as firms under conditions of ambiguity. Findings support implications of the Einhorn-Hogarth ambiguity model: (1) For low probability-of-loss events, prices of both consumers and firms indicated aversion to ambiguity; (2) As probabilities of losses increased, aversion to ambiguity decreased, with consumers exhibiting ambiguity preference for high probability-of-loss events; and (3) Firms showed greater aversion to ambiguity than consumers. The results are shown to be incompatible with traditional economic analysis of insurance markets and are discussed with respect to the effects of ambiguity on the supply and demand for insurance.

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University of Chicago Graduate School of Business

University of Pennsylvania The Wharton School

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Hogarth, R.M., Kunreuther, H. Risk, ambiguity, and insurance. J Risk Uncertainty 2, 5–35 (1989). https://doi.org/10.1007/BF00055709

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Key words

  • Ambiguity
  • expected utility
  • insurance
  • risk
  • subjective probability