Risk, Ambiguity, Insurance, and the Winner's Curse1

Journal of Risk and Uncertainty, 2011

This paper reports the results of the first experiment in the United States designed to distinguish between two sources of ambiguity: imprecise ambiguity (expert groups agree on a range of probability, but not on any point estimate) versus conflict ambiguity (each expert group provides a precise probability estimate which differs from one group to another). The specific context is whether risk professionals (here, insurers) behave differently under risk (when probability is well-specified) and different types of ambiguity in pricing catastrophic risks (floods and hurricanes) and non-catastrophic risks (house fires). The data show that insurers charge higher premiums when faced with ambiguity than when the probability of a loss is well specified (risk). Furthermore, they tend to charge more for conflict ambiguity than imprecise ambiguity for flood and hurricane hazards, but less in the case of fire. The source of ambiguity also impacts causal inferences insurers make to reduce their uncertainty.

SSRN Electronic Journal, 2000

Journal of Risk and Uncertainty, 2015

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 Two apparently conflicting puzzles consistently arise out of the empirical observation of insurance markets. Both involve a tendency to make suboptimal insurance decisions and have important implications for environmental risk mitigation, consumer decision making, public finance, and firm profit maximization. First, there is substantial evidence that individuals and businesses underinsure catastrophe risk (Kunreuther and

2012

This paper investigates how the general public behaves when confronted with low probability events and ambiguity in an insurance context. It reports the results of a questionnaire completed by a large representative sample of the French population that aims at separating attitudes toward risk, imprecision and conict and at determining if there is a demand for ambiguous and extreme event risks. The data show a strong distinction between two aspects of the problem: the decision of purchasing insurance and the willingness to pay. In the decision to insure, more than 25% of the respondents refuse to buy insurance and people are more willing to insure in a risky situation than in an ambiguous one. This certain taste for risk can be explained by the respondents' observable characteristics. In addition, it highlights a lack of condence in the insurance markets. When it comes to willingness to pay, people exhibit ambiguity seeking behaviors. They are willing to pay more under risk than under ambiguity (embracing here imprecision and conict), revealing that people consider ambiguous situations as inferior. Furthermore, respondents behave dierently under imprecision and conict. They exhibit a preference for consensual information and dislike conicts. However, the willingness to pay is poorly correlated with observable characteristics.

2007

This paper considers financial markets for uncertain cashflow streams when participants are averse to model or parameter uncertainty, or more generally averse to ambiguity. Motivated by the desire to better understand why it is difficult to sell rainfall insurance in the developing world, this paper provides theoretical foundations for a type of constraint on private insurance markets intuitively understood by practitioners but not yet satisfactorily incorporated into theory. It is argued that prudential requirements and information asymmetries cause financial institutions to be better modelled as ambiguity averse decision-makers than expected profit maximisers. The model presented also offers explanations for the almost exclusive use of traditional insurance policies which closely match the risk to be insured, and the absence of indexed products as suggested by Shiller (2003). * A dissertation submitted in partial fulfillment of the requirements for the Specialist Applications Dissertation option (SA0) for the qualification of Fellow of the Institute of Actuaries. The word count, including all footnotes and references (but excluding equations) is 12, 170 words. An earlier version of this work, written to be read by academic economists, was submitted as a dissertation for the M.Phil. in Economics at Oxford University. I am indebted to my supervisors James Orr and Stefan Dercon for considerable guidance and encouragement. I am also grateful for helpful discussions with

2011

This paper investigates how people behave when confronted with low probability events and ambiguity in an insurance context. It reports the results of an experiment submitted to a large representative sample of the French population that aims at separating attitudes toward risk, imprecision and conflict and at determining if there is a market for ambiguous and extreme event risks. The data show a strong distinction between two decisions: the decision of purchasing insurance or not, and the decision of the willingness to pay for insurance. In the first decision, results reveal that more than 25% of the respondents refuse to buy insurance and that people are more willing to buy insurance in a risky situation than in an ambiguous one. Besides revealing a certain taste for risk, it also highlights a lack of confidence in the insurance markets. In addition, the decision to insure can be explained by certain observable characteristics of the respondents. In the second decision, the results point out that people are willing to pay more under risk than under ambiguity (embracing here imprecision and conflict). Furthermore, respondents accept a higher premium under conflict than under imprecision, which reveals a preference for consensual information. However, it is not possible to find a set of observable characteristics explaining the level of the insurance premium.

2013

Cette thèse vise à mieux comprendre les décisions individuelles des acteurs des marchés de l'assurance et de la réassurance face à différents types d'information, la couverture des risques extrêmes, et les arrangements contractuels entre assureurs et réassureurs. Le contexte général de l'assurance des risques extrêmes est marqué par une intensification et un accroissement des catastrophes naturelles et industrielles depuis une vingtaine d'années dans le monde, ce qui rend délicat une évaluation correcte des caractéristiques des événements et questionne l'assurabilité de ces risques du fait de la présence d'incertitudes. La thèse est constituée de deux parties utilisant une large palette d'outils quantitatifs. La première partie se concentre sur l'analyse des effets de l'information sur les décisions d'assurance, en particulier sur les primes que les agents sont prêts à payer ou accepter pour transférer ou supporter des risques spécifiques. L&#...

Pickering & Chatto, 2010

Journal of Risk Research, 2019

Little systematic research has investigated differences in expressed attitude as a function of the manner in which probability information is communicated to a decision maker. The purpose of this paper is to investigate differences in expressed attitude when insurance coverage is introduced in a known-risk situation (the probability of loss is known), an uncertain situation (there is no prior information on the probability of loss) or an ambiguous (the information provided is vague). The experiments reported in this paper have been developed and tested in the classroom with undergraduate students. Unlike the vast majority of previous work dealing with lotteries and laboratory gambles, this study examine the behavior of people when facing a purchase decision on a well-known consumer good, i.e. a bottle of wine. The comparative results provide some evidence on the risk-taking behavior of consumers for small losses. Within an insurance context, people prefer the more familiar option of a known-risk situation and contrary to expectations, the results do not provide support to ambiguity aversion but to ambiguity seeking.

Kindle Direct Publishing, 2019

This text provides an introduction to the analysis of economic decisions under uncertainty, with particular focus on insurance markets. "The Economics of Uncertainty and Insurance" is relatively short (220 pages) and richly illustrated with 80 figures. It is suitable for both self-study and as the basis for an upper-division undergraduate course. The book is written to be accessible to anyone with minimum knowledge of calculus, in particular the ability to calculate the derivative of a function of one variable. At the end of each chapter there is a collection of exercises that are grouped according to that chapter's sections. Complete and detailed answers for each exercise are given in the last section of each chapter. The book contains a total of 88 fully solved exercises.