revised version joint with Helge Braun published in: Geneva Risk and Insurance Review, 2007, 32(1), 61-90
We analyze dynamic interactions between market insurance, the stock of insurable assets
and liquid wealth accumulation in a model with non-durable and durable consumption. The
stock of the durable is exposed to risk against which households can insure. Since the model
does not have a closed form solution we first provide an analytical approximation for the case
in which households own abundant liquid wealth. It turns out that precautionary motives still
matter because of fluctuations of the predetermined durable stock. Second we solve the
model numerically. With deterministic labor income the representative agent demands a nonnegligible
amount of market insurance. The deductible is substantially higher than in static
models because agents can time-diversify their risk. Market insurance implies welfare gains
of around .6% in terms of non-durable consumption. Introducing labor income risk into the
model does not necessarily increase the importance of market insurance if the borrowing
constraint endogenously tightens.
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