Expanding the Scope of Individual Risk Management: Moral Hazard and Other Behavioral Considerations

Abstract

There is a large potential for improving individual risk management through new risk management contracts and associated newindex-settled derivatives. However, there are some difficult problems in designing contracts so that they will be used effectively. Individuals have idiosyncratic individual risks that can be hedged only at some real resource cost due to moral hazard. Individuals seem to exhibit behavior indicative of lack of appreciation of the principles of risk management. These problems are discussed, and some potential new risk management contracts that would make improvements in the management of major income risks are proposed. Despite a proliferation of derivative contracts around the world in recent decades, most of the risks that people face are still not being effectively hedged. Consider, for example, the risk to personal income that the representative individual in a country has. We can obtain an impression of the potential magnitude of this risk by looking a...