An experimental investigation of earthquake risk mitigation alternatives: the case of Turkey

The present study aims to empirically investigate the two risk reduction mechanisms,namely, self-insurance and market insurance.Market insurance is the insurance mechanism available in the market, however, self-insurance is the protective mechanism that reduces the loss size of the event, but not the probability of the occurrence of the event. According to the Expected Utility Theory, both self-insurance and market insurance can be equally valuated since they result in the increase in expected utility by making the adverse events outcomes worse. However, Ehrlich and Becker (1972) proved that these two mechanisms are substitutes to each other (that is also supported by Courbage, 2001). Altough there are many theoretical works about this isuue (e.g.,Immardino, 2000; Quiggin, 2002; Lee, 2005; Lohse et al., 2007), we are aware of only two experimental studies: Shogren (1990) and Di Mauro and Maffioletti (1996) showed that no significant difference exists between the two risk management tools. In the present study, we examine these two mechanisms through conducting an experiment. Different from the previous works, we design the experimental setting based on context scenarios. More specifically, earthquake is taken as the risk that causes loss and market insurance is the available earthquake insurance in Turkish market (Turkish Compulsory Insurance Pool, TCIP) and self-insurance is the protective mechanism that can be purchased by individuals to strengthened the house against earthquake losses which has no influence on the probability of the occurrence of the earthquake but can reduce the loss size. The individual valuations/demands for these mechanisms to reduce earthquake risk are
analyzed through conducting an experiment to 78 students from Middle East Technical University. In addition, the effects of risk attitude, personality traits, and demographic variables (that are measured through using a questionnaire) on valuations to these precautionary actions’ are examined. The findings show that, consistent with the theory, self-insurance and market insurance are substitutes to each other and subjects prefer self-insurance mechanism to market insurance. Lastly, individual investment attitude is found to affect the valuations of these two risk reduction mechanisms positively concluding that people perceive these mechanisms as investment tools.