OPTIMAL INSURANCE DESIGN UNDER RANK‐DEPENDENT EXPECTED UTILITY

Mathematical Finance - Tập 25 Số 1 - Trang 154-186 - 2015
Carole Bernard1, Xuedong He2, Jia-an Yan3, Xun Yu Zhou4
1University of Waterloo
2Columbia University
3Chinese Academy of sciences
4The Chinese University of Hong Kong and University of Oxford

Tóm tắt

We consider an optimal insurance design problem for an individual whose preferences are dictated by the rank‐dependent expected utility (RDEU) theory with a concave utility function and an inverse‐S shaped probability distortion function. This type of RDEU is known to describe human behavior better than the classical expected utility. By applying the technique of quantile formulation, we solve the problem explicitly. We show that the optimal contract not only insures large losses above a deductible but also insures small losses fully. This is consistent, for instance, with the demand for warranties. Finally, we compare our results, analytically and numerically, both to those in the expected utility framework and to cases in which the distortion function is convex or concave.

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