# The effect of ambiguity on risk management choices: An experimental study

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## Abstract

We introduce a model of the decision between precaution and insurance under an ambiguous probability of loss and employ a novel experimental design to test its predictions. Our experimental results show that the likelihood of insurance purchase increases with ambiguous increases in the probability of loss. When insurance is unavailable, individuals invest more in precaution when the probability of loss is known than when it is ambiguous. Our results suggest that sources of ambiguity surrounding liability losses may explain the documented tendency to overinsure against liability rather than meet a standard of care through precaution. The results provide support for our theoretical predictions related to risk management decisions under alternative probabilities of loss and information conditions, and have implications for liability, environmental, and catastrophe insurance markets.

## Keywords

Liability Imperfect information Design of experiments Laboratory experiments## JEL Classifications

K130 D81 C9 C920## Notes

### Acknowledgments

The authors would like to thank the anonymous referee, the Editor Kip Viscusi, Glenn Harrison, James Sundali, Bill Rankin, and seminar participants at Colorado State University, Ludwig-Maximilian University, University of Münster, and at a Behavioral Insurance Workshop sponsored by the Georgia State University Center for the Economic Analysis of Risk for helpful comments on earlier drafts of this paper. They are grateful for financial support from the Colorado State University College of Business and the Nevada Insurance Education Foundation.

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