Self‐Insurance, Self‐Protection, and Saving: On Consumption Smoothing and Risk Management

Abstract

This article studies the effect of risk preferences on self‐insurance and self‐protection in a two‐period expected utility framework. Here the investment to reduce risk precedes its effect. In contrast to single‐period models, self‐insurance and self‐protection react similarly when the agent's utility function becomes more concave. Effort is increased if and only if current consumption is sufficiently large. However, if we introduce endogenous saving, an agent with more concave utility always selects more self‐insurance, but will select more self‐protection if and only if the probability of loss is small enough. These latter results concur with those in standard monoperiodic models with no saving.