The Interdependence of Individual Portfolio Decisions and the Demand for Insurance

Abstract

We analyze the individual's demand for insurance as a special case of general portfolio hedging activity. The demand for insurance contracts is determined simultaneously with the demands for other assets in the portfolio. We demonstrate that when the payoffs of the policy are correlated with the payoffs to the individual's other assets, the demand for insurance contracts is generally not a separable portfolio decision. We argue that this separability condition is not generally met because of significant interdependence of claims across different insurance policies. Furthermore, our generalizations can reverse the standard prediction that wealthier individuals will demand less insurance.