Insurance and portfolio decisions: Two sides of the same coin?

We study insurance and portfolio decisions, two opposite risk retention tradeoffs. Using household level data, we identify the first joint determinants (e.g. subjective expectations, risk attitude) and frictions (e.g. liquidity constraints, financial literacy) in the literature. We also find key differences between the two decisions. Notably, contrary to economic intuition, risky asset holding and insurance coverage both increase with wealth. We show that this apparent puzzle is driven in part by a specific behavioral pattern (the poor invest too conservatively, while the rich over-insure), and can be explained by two factors: regret avoidance and nonperformance risk.(c) 2023 Elsevier B.V. All rights reserved.

Automated summary

We study the determinants and frictions of insurance and portfolio decisions using household level data, and find key differences between the two decisions. Contrary to economic intuition, risky asset holding and insurance coverage increase with wealth. This can be explained by a behavioral pattern where the poor invest too conservatively and the rich over-insure, driven by regret avoidance and nonperformance risk.