Is insurance normal or inferior?-A regret theoretical approach

This study considers how changes in wealth affect insurance demand when individuals suffer disutility from regret. Anticipated regret stems from a comparison between the ex-post maximum and actual wealth. We consider a situation wherein individuals maximize their expected utility incorporating anticipated regret. The wealth effect on insurance demand can be classified into the risk and the regret effects. These effects are determined by the properties of the utility function and the regret function. We show that insurance can be normal when individuals place weight on anticipated regret, even though the utility function exhibit decreasing absolute risk aversion. This result indicates that regret theory is a possible explanation to the wealth effect puzzle, in which insurance is normal from empirical observation, but it should be inferior by theoretical prediction under expected utility theory.

Automated summary

This study examines how changes in wealth affect insurance demand when individuals experience disutility from regret. The wealth effect on insurance demand can be categorized into risk and regret effects based on the properties of the utility function and the regret function. It is shown that insurance can be normal even with decreasing absolute risk aversion in the utility function, when individuals place emphasis on anticipated regret.