On the Role of Market Insurance in a Dynamic Model

Durables such as cars or houses are a substantial component in the balance sheets of households. These durables are exposed to risk and can be insured in the market. We build a dynamic model in which the agent decides jointly about the size of the durable stock, the stock of a risk-free asset and insurance. This allows us to understand the importance of three di¤erent ways to cope with the risk exposure of the durable stock: (i) purchase of market insurance, (ii) bu¤er-stock saving of the riskless asset or (iii) adjustment of the durable stock. Compared with previous research that did not allow for an endogenous size of the loss, we …nd that the policy function for market insurance can be non-monotonic in the agent’s resources since the covariance between the marginal utility of non-durable consumption and the loss depends both on the stock of risk-free assets and the durable. We calibrate our model to the US economy and …nd a small role for market insurance even if we add background risk such as volatile permanent labor income. a: Northwestern University, Evanston; b: IZA and University of Bonn; c: Finance and Consumption in the EU at the European University Institute, Florence. We thank Thomas Hintermaier, Robert Young and participants at various seminars and conferences for very helpful comments. Corresponding author: Winfried Koeniger, IZA, P.O. Box 7240, 53072 Bonn, Germany; [email protected]