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 DEPFID Working Paper  3 / 2010 - Abstract

De Finetti on insuring uncertainty

Alberto Feduzi*, Jochen Runde**, and Carlo Zappia***

In the insurance literature it is often argued that private markets can provide insurance against ‘risk’ but not against ‘uncertainties’ in the sense of Knight (1921) or Keynes (1921). This claim is at odds with the standard economic model of risk exchange which, in assuming that decision-makers are always guided by precise point-valued subjective probabilities, predicts that all uncertainties can, in theory, be insured. Supporters of the standard model argue that the insuring of highly idiosyncratic risks by Lloyd’s of London proves that this is so even in practice. The purpose of this paper is to show that Bruno de Finetti, widely regarded as one of the three founding fathers of the subjective approach to probability assumed by the standard model, actually made a theoretical case for uncertainty within the subjectivist approach. We draw on empirical evidence from the practice of underwriters to show how this case may help explain the reluctance of insurers to cover highly uncertain contingencies.

Keywords: uncertainty, insurance, probability, de Finetti

JEL Classification: B23, D80, G22.

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* Department of Economics, University of Rome III, Rome, Via Silvio D’Amico 77, 00145, Italy, and Judge Business School, University of Cambridge, Trumpington Street, Cambridge CB2 1AG, UK. 

** Judge Business School, University of Cambridge, Trumpington Street, Cambridge CB2 1AG, UK.

*** Department of Economic Policy, Finance and Development, University of Siena, Piazza San Francesco 7, 53100 Siena, Italy