Reading 12 pg 411 - insurance demand and allocation to rf asset

[hei.so]

As the correlation between the risky asset and the income flow increases, the ex ante value of human capital to the surviving family decreases.
What does this mean? I know that the demand for insurance decreases as HC decreases but I don’t get why HC decreases in the statement above. If the correlation between risky asset and income increases, would you not want more life insurance to hedge?

 

[cpk123]

more risky the asset - the rate at which you discount that asset becomes higher - so the HC becomes discounted at a higher rate. that means PV of the HC is lower. Once you have lower HC - you do not have the need to insure it as much.
you need higher life insurance if your HC value is higher.

 

[caschas]

Yes,
I also found the way Life Insurance is related to Human Capital counter intuitive as we would go to think; the more uncertainty I have about my future, the more I will be prone to hedge myself on future losses => Risky Salary = More need to ensure my HC.
I think it’s more about the insurability of the HC than the need to have insurance.
A volatile HC is not properly insurable as there is too much uncertainty on his future value.
- I don’t know how much I am valued => nobody wants to ensure me
- I have a stable valuation of myself => I’ll want to protect that and we can put a price on it
I found it strange they said we wouldn’t need it…

 

[hei.so]

Thanks! Great explanation from the both of you. It does seem counter-intuitive but it does make sense this way.