infonet-economy

Although insurance is the typical textbook example for an asset that negatively correlates with consumption, the suitability of the classical consumption-based asset pricing model with power utility to explain historical premiums and claims has not yet been tested. We fill this gap by fitting the model to property-casualty market data for Australia, Germany, Italy, Japan, Netherlands, and the United States. In doing so, we find evidence of yet another asset pricing anomaly. More specifically, the consumption-based model implies even larger relative risk aversion coefficients in the insurance sectors than in the equity markets of the aforementioned countries. To solve this puzzle, we draw on the loss aversion and narrow framing approach by Barberis et al. (2001) as well as the second-degree expectation dependence framework by Dionne et al. (2015), with encouraging results.