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Domain-specific risk and public policy
1 : Labour Institute for Economic Research
(LIER)
Pitkansillanranta 3 A -
Finland
2 : Jyväskylä University School of Business and Economics, Labour Institute for Economic Research and IZA
3 : labour institute for economic research
We develop a novel method to estimate domain-specific risk. We apply the method to sickness insurance by fitting a utility function at the individual level, using European and UK survey data on life satisfaction. Four results stand out. First, marginal utility is higher in the sick state, conditional on income, due to a fixed cost of sickness. Second, relative risk aversion increases with income. Third, the domain-specificity of risk shifts the focus to the smoothing of utility, not consumption. Fourth, the optimal policy rule implies that the replacement rates are not generally linear.
