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Loss aversion leading to advantageous selection

Author

Listed:
  • Christina Aperjis

    (Power Auctions LLC)

  • Filippo Balestrieri

    (Analysis Group)

Abstract

Some insurance markets are characterized by “advantageous selection”, that is, ex-post risk and coverage are negatively correlated. We show that expectation-based loss aversion as in Kőszegi and Rabin (Quarterly Journal of Economics, 121(4), 1133–1165, 2006; The American Economic Review, 97(4), 1047–1073, 2007) provides a natural explanation for this phenomenon in environments in which risk aversion models do not, e.g., when agents face modest-scale risks and/or in absence of moral hazard. More exposure to risk has two competing effects on an agent’s willingness to pay for insurance: a positive effect, as in standard expected utility models; and a negative one, due to a reference effect. We determine conditions under which an insurance provider optimally sets a high price at which only low risk agents buy.

Suggested Citation

  • Christina Aperjis & Filippo Balestrieri, 2017. "Loss aversion leading to advantageous selection," Journal of Risk and Uncertainty, Springer, vol. 55(2), pages 203-227, December.
    • Handle: RePEc:kap:jrisku:v:55:y:2017:i:2:d:10.1007_s11166-017-9269-8
    DOI: 10.1007/s11166-017-9269-8
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    More about this item

    Keywords

    Loss aversion; Advantageous selection; Insurance; Risk;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D42 - Microeconomics - - Market Structure, Pricing, and Design - - - Monopoly

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