Volume 7, Issue 3, 47-56.

Consumer Behavior and Demand for Insurance Under Uncertainty: The Continuous Time Case study

Naziha KASRAOUI

Département de Gestion, Finance, Université de Tunis, Institut Supérieur de Gestion de Tunis, Tunisia.

Kaïs BEN-AHMED*

Département de Gestion, MQ, Université de Sousse, Institut Supérieur de Finances et de Fiscalité de Sousse, Tunisia.

Mounira BEN-ARAB

Département de Gestion, Finance, Université de Tunis, Institut Supérieur de Gestion de Tunis, Tunisia.

ABSTRACT

Intertemporal models in finance and economics traditionally are based on time-separable preferences. Utility over time is a simple discounted aggregation of utility at each point in time. A basic problem with this approach is that it does not allow for the disentangling of the elasticity of intertemporal substitution from the individual’s degree of risk aversion. Several empirical puzzles arise as a result of this approach, such as the behavior of aggregate consumption, which appears to be much less volatile than predicted by theory. We experimentally investigate habit formation or “preferences dependencies” in consumption behavior of consumers. We allow the consumer to acquire a “taste for the good life” by making current preferences for consumption depending upon the individuals of past consumption. Individual’s make consumption decisions in an environment with two central features: first, they have a regular income in the beginning of each period; and second, there exist a varying probability of loss on the income. A joint treatment of the insurance and consumption decisions is applied to a real experimental data set of 66 individuals who participate to the experience. Experimental economic method gives very promising results. The optimal consumption path is smoother and the optimal level of insurance greater in this setting than they are in an identical model without habit formation. Moreover, the optimal level of insurance increases over the planning horizon, approaching full coverage in the limit. These results help to explain the observed phenomenon of individual’s over-purchasing insurance, such as a propensity for low deductibles.

JEL Classification: D81; D91; D12.

Keywords: Consumption; Insurance; Habit Formation; Behavior; Loss Aversion; Decision.

*Corresponding author. 36 Avenue Taïeb El M’hiri Bardo 2000, Tunisia; phone: + (216) 23 625 235; E-mail: Kais.BenAhmed@isg.rnu.tn.

 

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