We define a premium principle under the continuous cumulative prospect theory which extends the equivalent utility principle. In prospect theory risk attitude and loss aversion are shaped via a value function, whereas a transformation of objective probabilities, which is commonly referred as probability weighting, models probabilistic risk perception. In cumulative prospect theory, probabilities of individual outcomes are replaced by decision weights, which are differences in transformed, through the weighting function, countercumulative probabilities of gains and cumulative probabilities of losses, with outcomes ordered from worst to best. Empirical evidence suggests a typical inverse-S shaped function: decision makers tend to overweight small probabilities, and underweight medium and high probabilities; moreover, the probability weighting function is initially concave and then convex. We study some properties of the behavioral premium principle. We also assume an alternative framing of the outcomes; then we discuss several applications to the pricing of insurance contracts.

Insurance premium calculation under continuous cumulative prospect theory

Martina Nardon
;
Paolo Pianca
2019

Abstract

We define a premium principle under the continuous cumulative prospect theory which extends the equivalent utility principle. In prospect theory risk attitude and loss aversion are shaped via a value function, whereas a transformation of objective probabilities, which is commonly referred as probability weighting, models probabilistic risk perception. In cumulative prospect theory, probabilities of individual outcomes are replaced by decision weights, which are differences in transformed, through the weighting function, countercumulative probabilities of gains and cumulative probabilities of losses, with outcomes ordered from worst to best. Empirical evidence suggests a typical inverse-S shaped function: decision makers tend to overweight small probabilities, and underweight medium and high probabilities; moreover, the probability weighting function is initially concave and then convex. We study some properties of the behavioral premium principle. We also assume an alternative framing of the outcomes; then we discuss several applications to the pricing of insurance contracts.
University Ca' Foscari of Venice, Dept. of Economics Research Paper Series
File in questo prodotto:
File Dimensione Formato  
WP_DSE_nardon_pianca_03_19.pdf

accesso aperto

Descrizione: Articolo principale
Tipologia: Documento in Post-print
Licenza: Accesso libero (no vincoli)
Dimensione 1.61 MB
Formato Adobe PDF
1.61 MB Adobe PDF Visualizza/Apri

I documenti in ARCA sono protetti da copyright e tutti i diritti sono riservati, salvo diversa indicazione.

Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/10278/3713110
Citazioni
  • ???jsp.display-item.citation.pmc??? ND
  • Scopus ND
  • ???jsp.display-item.citation.isi??? ND
social impact