Degree of Risk Aversion and Demand for Insurance of Households in the Presence of Background Risk
Date Issued
2009
Date
2009
Author(s)
Lin, Feng-Teng
Abstract
Essay 1 of this study uses life insurance expenditure data of Survey of Family Income and Expenditure (SFIE) in Taiwan to estimate the Arrow-Pratt risk aversion coefficient of households empirically by using the reduced form equation derived by Halek and Eisenhauer (2001). This study provides empirical evidence on the nature of the relationship between the risk aversion and background risk which is not under the control of the agent, and that is independent of endogenous risks. Using the coefficient variation of household income as the proxy for background risk, after controlling other factors including household income and wealth, the characteristics of the head of household and other demographic variables, the results suggest that households which are more likely to face higher income risk exhibit a greater coefficient of risk aversion. This finding is consistent with consumer preferences being characterized by proper risk aversion (Pratt and Zeckhauser, 1987), standard risk aversion (Kimball, 1993) and risk vulnerability (Gollier and Pratt, 1996) which are the necessary and sufficient conditions of the optimal risk-taking behavior in the presence of background risk.ssay 2 of this study investigates how background risk affects households’ insurance purchasing decision, expenditure share and amounts of insurance by using data of Survey of Family Income and Expenditure (SFIE) in Taiwan. Using the income risk as the proxy for background risk and controlling other wealth and demographic factors, the findings suggest that insurance expenditure is positively affected by uninsurable background risk. This results suggest that consumer with more income risk is more risk averse and leads a higher demand of insurance. This finding is similar to the empirical results of Guiso and Jappelli (1998) and Koeniger (2004) and is consistent with the theory models derived by Eeckhoudt and Kimball (1992) and Schlesinger (1999). This finding is also consistent with consumer preferences being characterized by proper risk aversion, standard risk aversion and risk vulnerability. This study also finds that the coefficient income elasticity of insurance is positive that means people tend to increase insurance expenditure with respect to an increase in income. This result is consistent with most empirical studies of insurance demand that suggest that a consumer’s income change has positive effect on the consumer’s demand for insurance and suggest that insurance is a normal good.
Subjects
Risk aversion
Background risk
Income risk
Demand for insurance
Income elasticity
Type
thesis
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