Insurance and Portfolio Decisions: A Wealth Effect Puzzle
Abstract
:
In a standard economic model, the decision to invest in risky asset
s and the decision to insure against the risk of loss reflect the same, alb
eit opposite, risk retention tradeoff. Insurance and portfolio decisions sh
ould therefore produce similar, but opposite, behavior and comparative stat
ics. In this paper we test whether, consistent with standard theory, the we
alth elasticity of demand for insurance and risky assets have opposite sign
s. We do so using survey data for a representative sample of U.S. household
s which combines comprehensive individual level information on wealth and i
nsurance coverage. The empirical analysis produces two main results: we fin
d strong evidence that insurance is a normal good (an important result in i
tself), and we identify a puzzle in the sense that, contrary to standard th
eory, the wealth elasticity of demand for risky assets and insurance have t
he same positive sign. We try to explain this puzzle using conventional and
behavioral theories, but we conclude that none of these approaches are con
vincing at explaining the puzzle.