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With regards to 1: So? Buying options is buying insurance. From the point of view of the purchaser, the expected value of buying insurance is always negative (

With regards to 1: So? Buying options is buying insurance. From the point of view of the purchaser, the expected value of buying insurance is always negative (otherwise insurance sellers would be out of business). However, insurance is not bought due to its EV, it is bought due to its variance-minimizing properties.

ucaetano 11y ago
Not really, insurance is bought by people because of the non-linear utility function of money: losing $1 million has a far more negative utility that 1000 times the utility of losing $1000. The same with lottery tickets. People don't buy them because they're stupid, but because they value $100M far more than 50M times the value of $2.
- msandford 11y ago
  I love that you think there is one and only one reason to buy insurance. I suspect that people buy insurance for both reasons. Which is to say that you're both right, and both a little bit wrong.
  - ucaetano 11y ago
    Oh no, I don't think there's ever a single reason for anything. People don't buy insurance to reduce variability, since people don't care about positive variability, only negative (as in the lottery example). Some people buy just because other people tell them to, some because they are afraid of losing something, and so on, there are a thousand reasons why individuals do it. But the general trigger of insurance for people is the non-linear utility function.
    - msandford 11y ago
      > But the general trigger of insurance for people is the non-linear utility function. I would respectfully disagree. Homeowners insurance is a great example. Most people buy it and never make a claim, and they "lose" insofar as their premiums are gone for no monetary return. But some people who buy it "win" and get to collect enough money to roughly replace their house, belongings, etc when a hurricane, tornado or whatever destroys it all. Not all insurance is the kind where you pay the same amount whether you make 1000 small payments or one big one.
      - ucaetano 11y ago
        "Not all insurance is the kind where you pay the same amount whether you make 1000 small payments or one big one." But I never said that! It's just like the lottery, the payout of the lottery is smaller than the price divided by the odds (that's why a lot of people call it a tax on people who don't know math), but as the utility function of money isn't linear, for most people a small chance of gaining a lot of money is more valuable than a little bit of money. The same is valid for insurance. The value of losing a lot of money is far more negative than the cost of it, even when taking the risk in account. That's because the utility function doesn't depend only on the gain, but also on how much you have. A billionaire might not care about home insurance for a 100k shack.
        msandford 11y ago
        Even if the utility function was linear, I'd still prefer to insure some things, even with a negative expected value, for the sake of smoothing variance. EDIT: I'll clarify this to mean; even if the EV of insurance was exactly neutral, I'd still buy it for smoothing. And even if the EV was negative, I'd still buy it for smoothing. There's a difference between smoothing and loss aversion.
        ucaetano 11y ago
        Not for smoothing variance, as you don't care about positive veriations. You'd buy it to limit your downside. If people would buy it to minimize variance, they would also pay an insurance against winning the lottery.
        msandford 11y ago
        Some people choose to take 20 years of monthly payments from lottery winning rather than one lump sum. "Rationally" anyone who does that is a fool, and yet people constantly do that. Perhaps there's value to variance minimization, aside from the non-linear utility function of money?

ucaetano 11y ago

Not really, insurance is bought by people because of the non-linear utility function of money: losing $1 million has a far more negative utility that 1000 times the utility of losing $1000. The same with lottery tickets. People don't buy them because they're stupid, but because they value $100M far more than 50M times the value of $2.

msandford 11y ago
I love that you think there is one and only one reason to buy insurance. I suspect that people buy insurance for both reasons. Which is to say that you're both right, and both a little bit wrong.
- ucaetano 11y ago
  Oh no, I don't think there's ever a single reason for anything. People don't buy insurance to reduce variability, since people don't care about positive variability, only negative (as in the lottery example). Some people buy just because other people tell them to, some because they are afraid of losing something, and so on, there are a thousand reasons why individuals do it. But the general trigger of insurance for people is the non-linear utility function.
  - msandford 11y ago
    > But the general trigger of insurance for people is the non-linear utility function. I would respectfully disagree. Homeowners insurance is a great example. Most people buy it and never make a claim, and they "lose" insofar as their premiums are gone for no monetary return. But some people who buy it "win" and get to collect enough money to roughly replace their house, belongings, etc when a hurricane, tornado or whatever destroys it all. Not all insurance is the kind where you pay the same amount whether you make 1000 small payments or one big one.
    - ucaetano 11y ago
      "Not all insurance is the kind where you pay the same amount whether you make 1000 small payments or one big one." But I never said that! It's just like the lottery, the payout of the lottery is smaller than the price divided by the odds (that's why a lot of people call it a tax on people who don't know math), but as the utility function of money isn't linear, for most people a small chance of gaining a lot of money is more valuable than a little bit of money. The same is valid for insurance. The value of losing a lot of money is far more negative than the cost of it, even when taking the risk in account. That's because the utility function doesn't depend only on the gain, but also on how much you have. A billionaire might not care about home insurance for a 100k shack.
      - msandford 11y ago
        Even if the utility function was linear, I'd still prefer to insure some things, even with a negative expected value, for the sake of smoothing variance. EDIT: I'll clarify this to mean; even if the EV of insurance was exactly neutral, I'd still buy it for smoothing. And even if the EV was negative, I'd still buy it for smoothing. There's a difference between smoothing and loss aversion.
        ucaetano 11y ago
        Not for smoothing variance, as you don't care about positive veriations. You'd buy it to limit your downside. If people would buy it to minimize variance, they would also pay an insurance against winning the lottery.
        msandford 11y ago
        Some people choose to take 20 years of monthly payments from lottery winning rather than one lump sum. "Rationally" anyone who does that is a fool, and yet people constantly do that. Perhaps there's value to variance minimization, aside from the non-linear utility function of money?