Ambiguity, ambiguity aversion and the coverage of uncertain risks : the case of the insurer

• Main Author: Chelwa, Grieve
• Other Authors: Pellicer, Miquel
• Format: Dissertation
• Language: English
• Published: University of Cape Town 2014
• Subjects: Economics
• Online Access: http://hdl.handle.net/11427/10215

Ambiguity aversion is defined as an aversion to any mean-preserving spread in the probability space. Using the Smooth Ambiguity Model proposed by Klibanoff, Marinacci and Mukerji (2005), we show that ambiguity aversion results in a reduction in the proportion of insurance coverage offered by an insurer. This is because an ambiguity averse insurer calculates expected utilities by using a 'distorted' probability that raises the marginal disutility of wealth in the loss state. We also show that, in general, an ambiguity averse insurer will not offer more coverage to wealthier agents. Wealthier agents enjoy more coverage when the subjective average probability of loss is significantly high. Our results go a long way in reconciling theoretical models of insurance under ambiguity with the empirical finding that insurers are sensitive to ambiguity.