Subprime Risk and Insurance with Regret

Table 8

Effect of regret on risk allocation and liquidity.

Cases	Behavior with respect to	Risk-averse SIB	Regret-averse SIB
Case 1:	Probability of investing	=0	>0
𝑟𝑞(𝑃)=^T𝜉𝑃	in subprime SMPs	∴𝜋^∗0=0	∴𝜋^∗𝜌>0
Case 2:	Probability of investing	=0	>0
𝑟𝑞(𝑃)≫^T𝜉𝑃	in treasuries	∴𝜋^∗0=1	∴𝜋^∗𝜌<1
Case 1:
𝑟𝑞(𝑃)=^T𝜉𝑃	Liquidity effect	High	Low
Case 2:
𝑟𝑞(𝑃)>^T𝜉𝑃	Liquidity effect	Low	Low if 𝜌≫0
𝑟𝑞(𝑃)≫^T𝜉𝑃		Lower	Higher if 𝜌≫0