Insurance makes wealth grow faster
arXiv:1507.04655
Abstract
Voluntary insurance contracts constitute a puzzle because they increase the expectation value of one party's wealth, whereas both parties must sign for such contracts to exist. Classically, the puzzle is resolved by introducing non-linear utility functions, which encode asymmetric risk preferences; or by assuming the parties have asymmetric information. Here we show the puzzle goes away if contracts are evaluated by their effect on the time-average growth rate of wealth. Our solution assumes only knowledge of wealth dynamics. Time averages and expectation values differ because wealth changes are non-ergodic. Our reasoning is generalisable: business happens when both parties grow faster.
27 pages, 3 figures, 3 tables, 1 glossary