Journal article
On the optimality of straight deductibles under smooth ambiguity aversion
Journal of economic behavior & organization, Vol.234, 107001
06/2025
DOI: 10.1016/j.jebo.2025.107001
Abstract
We solve the optimal insurance design problem under identifiable smooth ambiguity aversion with linear transaction cost. We impose monotonicity on indemnity schedules and their associated retention functions. Arrow’s cornerstone result that a straight deductible is optimal may fail to hold. We provide three conditions to restore it: (i) ambiguity does not affect large losses; (ii) priors are ordered according to first-order stochastic dominance and the probability of worse priors is greater conditional on observing a large loss than a small loss; or (iii) priors are ordered in the hazard rate order. We also derive comparative statics and find intuitive results.
•Three criteria for optimality of straight deductible with smooth ambiguity aversion.•Ambiguity does not affect large losses.•FSD ordering of priors and probability of worse priors increases in loss size.•Priors ordered in hazard rate order.•Intuitive comparative statics (degree of ambiguity aversion, level of ambiguity).
Details
- Title: Subtitle
- On the optimality of straight deductibles under smooth ambiguity aversion
- Creators
- Yichun Chi - Central University of Finance and EconomicsRichard Peter - University of Iowa, Department of Finance, Iowa City, IA 52240, USAWei Wei - University of Illinois Urbana-Champaign
- Resource Type
- Journal article
- Publication Details
- Journal of economic behavior & organization, Vol.234, 107001
- Publisher
- Elsevier B.V
- DOI
- 10.1016/j.jebo.2025.107001
- ISSN
- 0167-2681
- eISSN
- 1879-1751
- Grant note
- 12371479 / National Natural Science Foundation of China (http://dx.doi.org/10.13039/501100001809) 22JJD790090 / MOE (China) Project of Key Research Institute of Humanities and Social Sciences at Universities (http://dx.doi.org/10.13039/501100002338) University of Illinois Urbana-Champaign, United States (http://dx.doi.org/10.13039/100005302)
- Language
- English
- Date published
- 06/2025
- Academic Unit
- Economics; Finance
- Record Identifier
- 9984815910902771
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