TITLE
" A Behavioral Model of Insurance Pricing," James A. Ligon and Paul D. Thistle, Spring 2007, Volume 30, No. 46-61. Full-text articles soon will be available
through ABI/INFORM and EBSCO; click here for article PDF
ABSTRACT
We develop a model of price competition between insurers where insurers
maximize expected profit subject to a solvency constraint. Insurers base prices in part
on expected losses, the estimates of which are updated in a Bayesian fashion. We
assume that insurers are overconfident—they overestimate the precision of their
private signal about expected losses. This leads insurers to overreact to their private
signal on expected losses. The consequence is that prices may cycle and that the
distribution of price changes may be positively skewed because of the role played by
the solvency constraint. [Key words: cycles, overconfidence, overreaction].
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