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" A Behavioral Model of Insurance Pricing," James A. Ligon and Paul D. Thistle, Spring 2007, Volume 30, No. 46-61. Full-text articles soon will be available through ABI/INFORM and EBSCO; click here for article PDF

We develop a model of price competition between insurers where insurers maximize expected profit subject to a solvency constraint. Insurers base prices in part on expected losses, the estimates of which are updated in a Bayesian fashion. We assume that insurers are overconfident—they overestimate the precision of their private signal about expected losses. This leads insurers to overreact to their private signal on expected losses. The consequence is that prices may cycle and that the distribution of price changes may be positively skewed because of the role played by the solvency constraint. [Key words: cycles, overconfidence, overreaction].