Essay on Behavioral Models Of Finance And Economics

Essay on Behavioral Models Of Finance And Economics

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In the last decades scientists and practitioners have been applying behavioural models to finance and economics in order to explain customer’s behaviour. Many findings of numerous researches in these fields show similarities with the insurance market and could therefore be adapted to it. However, insurance is a complex and emotionally charged product, which requires its proper analysis of behavioural effects. This paper reviews some of the most discussed theories and recent studies in analyzing insurance demand from a behavioural perspective.

Since the economic foundation of insurance, the demand of insurance has been explained by the classical expected utility theory (EUT). This theory describes the level of sacrifice of wealth in order to prevent a loss of wealth, dependent on the individuals risk appetite. As a result, individuals can maximize their expected utility by paying insurance premiums to protect against the risk of a monetary loss. However, the underlying assumption within the contextual model of the EUT is that the individual’s decision making is described as purely rational and normative (Richter, Schiller & Schlesinger, 2014). Hsee and Kunreuther (2000) and many others have proven that seemingly purely monetary decisions can be heavily influenced by our emotions and can thus, affect our insurance purchase preferences.

The aim of this paper is to gain insight into the domain of behavioural insurance with a special focus on the demand of insurance. Therefore, the most common theories of behaviourism that may be of importance for the insurance industry are introduced herein after.

The probably most cited and well-known alternative approach is the prospect theory of Kahneman & Tversky (1979). In accordance to this ...

... middle of paper ...

...ustry. Within the last two decades, professional researches found several empirical evidence that prove the existence of behavioural-related triggers concerning the demand of insurance. Even though the significance of these experiments varies, the consensus of all studies remains the same - individuals are prone to act irrationally when their feelings and emotions have been affected. Especially after catastrophes have occurred, as they affect our emotions the most and they are highly recovered by media.

From my point of view, future studies shall focus on specific fields (e.g. increase in catastrophe insurance demand after an incident) and apply it to real cases as most studies are based on experiments. Furthermore, more theories of behavioural economics shall be applied to the insurance industry in order to understand “the big picture” of insurance demand drivers.

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