A Mean-Variance Analysis on the Interaction between Insurance and Risky Investment
Publisher : Korea Insurance Research Institute
Research Area : Business Management
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We re-examine the demand for insurance by considering the case where the individuals are allowed to purchase risky assets as well as insurance coverage. In our model the individuals are exposed to both insurable risk and investment risk, and so the risky investment decision is made simultaneously with the insurance decision. Our analysis is based on mean-variance criterion, which leads to very intuitive results about insurance purchase. The results show that risky investment can be used for reducing the overall portfolio risk, holding the portfolio expected value fixed. This demonstrates that the risky investment plays an obvious role of home-made insurance, specified in Mayers-Smith (1983). Moreover, in contrast to Mossin (1968), it can be optimal for the individuals to purchase full insurance even when insurance premium is positively loaded. Mossin's results are reduced to be a special case in our model. We also identify conditions for Mossin's results to hold. We also derive many interesting and important results on interdependence between insurance and investment,which may not be possible for a general expected utility model in most cases.
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