Three essays on insurance demand for ambiguous atemporal and temporal risks
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Drawing on the models of Klibanoff et al.(2005, 2009), Chapter 1 shows that, in the presence of ambiguity, fair pricing remains a necessary and sufficient condition for full insurance coverage to be optimal. This result holds in both atemporal and temporal contexts. With unfairly priced insurance for a temporal risk, a small amount of ambiguity aversion leads an ambiguity-averse insurance applicant to demand more coverage and save less than an applicant who is ambiguity-neutral when ambiguity preferences exhibit constant ambiguity aversion. This result holds for an arbitrary amount of ambiguity only when ambiguity preferences exhibit a critical degree of increasing absolute ambiguity aversion. Chapter 2 and 3 attempt to quantitatively confirm the results in Chapter 1 by assuming regular isoelastic specifications for utility functions. What is found is that for the highly regular isoelastic specification, coverage goes up as individual becomes more risk averse or ambiguity averse or both, though ambiguity aversion is not equivalent to an increase in risk aversion in terms of its effect on the strength of demand. In atemporal case and coverage goes up and saving goes down as either risk aversion or ambiguity aversion increases, the latter being consistent with the prediction for small introductions of ambiguity aversion reported in Chapter 1. Since the isoelastic functions may be amenable to empirical estimation, the way may be open to testing this conclusion empirically.