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The Determinants of the Insurance Demand by Firms

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  • Economics
  • History


firmra-summary.dvi The determinants of the insurance demand by firms Christian Gollier Toulouse School of Economics (LERNA and IDEI) July 22, 2007 Abstract In this paper, we provide a survey of the literature on why risks may be costly for firms, but also on why firms may find difficulty to insure them. A wide variety of arguments are provided, at the intersection of the economic theory of insurance, corporate finance, and decision theory. 1 Introduction The possibility to share risk is a cornerstone of our modern economies. Be- cause risk-sharing allows for risk-washing through diversification, it is useful for risk-averse consumers. It is also essential for entrepreneurship. With- out risk transfers, who could have borne alone the risk to build skyscrapers and airplanes, to invest in R&D, or to drive a car? Historians have well documented the role of private risk sharing devices in the development of trade in the middle ages, in particular in the case of sea transport. The suc- cesses of the Netherlands in the seventeenth century and of the England in the eighteenth century are strongly correlated with the emergence of finan- cial markets and insurance companies in those countries. The prohibition of insurance companies in France during the same period is one of the explana- tions for the late starting of the industrial revolution there.1 The importance of risk-sharing has recently been restated when insurance markets have been on the verge of collapsing after the events of September 11. The standard economic model of risk exchanges predicts that competi- tion on insurance markets leads to a Pareto-efficient allocation of risks in the economy. In particular, it states that all diversifiable risks in the economy will be washed away through mutual risk-sharing arrangements. All risks will be pooled in financial and insurance markets. Moreover, the residual system- atic risk in the economy will be borne by the agents who have a comparative advantage in risk management, as i

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