Evidence on Risk Preferences and the Role of Prospect Theory in Insurance

Abstract

Abstract This chapter reviews the empirical evidence regarding the role of risk preferences in the demand for insurance and gambling, and then considers the empirical evidence in support of a quid pro quo approach to the demand for insurance. The first part summarizes the empirical evidence on risk preferences, and also describes prospect theory and the standard interpretation of this theory. Next, the chapter looks at the evidence from a series of empirical and theoretical studies to determine whether the standard interpretation is actually how prospect theory should be interpreted when applied to the demand for insurance. Finally, the chapter shows how the prospect theory diagram can be transformed into one that shows the demand for insurance under the quid pro quo theory.

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