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RICHARD WATT, FRANCISCO J. VÁZQUEZ and IGNACIO MORENO AN EXPERIMENT ON RATIONAL INSURANCE DECISIONS ABSTRAC T. W e describe the results of an experiment on decision making in an insurance context. The experiment was designed to test for the underlying ration- ality of insurance consumers, where rationality is understood in usual economic terms. In particular, using expected utility as the preference function, we test for positive marginal utility, risk aversion, and decreasing absolute risk aversion, all of which are normal postulates for any microeconomic decision context under uncert ainty or risk. W e nd that there the discrepanc y from ration al decision mak- ing increases with the sophisticat ion of the rationality criteria , that irrational ity concerning fair premium contracts is uncharacteristically high, and that the slope of absolute risk aversion seems to depend on the format of the insurance contract. KEY WORDS: Contract format, Experiments, Insurance, Premiums, Rationality 1.  INTRODUCTION In order to arrive at useful conclusions, a general aspect of almost all microeconomic models is the underlying assumption of indi- vidual rationality. Certainly, the microeconomics of insurance is no exception. This becomes particularly important when the optimal design of insurance contracts is considered since, in order to cor- rectly address the preferences of insurance consumers, it is neces- sary to rstly assume that they are, in some sense, rational. Model- ling ratio nality no rmally imp lies the assumption of a given objec tive function (utility function), dened within a particular class of func- tions. For example, dening the utility function over wealth, and assuming that rationality implies (among other things) that more wealth is preferred to less, then the utility function must be within the class of strictly increasing functions. In this paper, we describe an experiment that was carried out with the objective of testing the underlying rationality of economic agents, within the context of choices among insurance contracts. W e dene three basic ‘orders of rationality’, with higher orders imply- ing greater sophistication as to the signs of the derivatives of the Theory and Decision  51:  247–296, 2001. © 2002 Kluwer Academic Publishers. Printed in the Netherlands.

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